How a Second Grader Beats Wall Street E-Book

Allan S. Roth

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 384

Veröffentlichungsjahr: 2009

Beschreibung

Straightforward strategies from a successful young investor In How a Second Grader Beats Wall Street, you'll follow the story of Kevin Roth, an eight-year-old who was schooled in simple approaches to sound investing by his father, seasoned financial planner Allan Roth, and discover exactly how simple it can be to become a successful investor. Page by page, you'll learn how to create a portfolio with the widest diversification and lowest costs; one that can move up your financial freedom by a decade and dramatically increase your spending rate during retirement. And all this can be accomplished by using some common sense techniques. Along the way, Kevin and his dad discuss fresh, new approaches to investing, and detail some tried-and-true, but lesser known approaches. They also take the time to debunk the financial myths and legends that many of us accept as true, and show you what it really takes to build long-term wealth with less risk. * Discusses how to design a portfolio composed of a few basic building blocks that can be "tweaked" to fit your personal needs * Addresses how you can reengineer your portfolio in order to stop needlessly paying taxes * Reveals how you can increase returns, regardless of which direction the market goes, by picking the "low-hanging fruit" we all have in our portfolios With just a little time and a little work, you can become a better investor. With this book as your guide, you'll discover how a simpler approach to today's markets can put you on the path to financial independence.

Leseprobe

Contents

Foreword

Acknowledgments

Introduction: The Seeds of Financial Success

Chapter 1: The Claw Will Take Your Money

The Common Sense of Kevin’s Math

The Arithmetic of Active Management

Can My Professional Really Beat Yours?

Why We Play a Loser’s Game

Kevin Doesn’t Play That Game

Chapter 2: Own the World

The Common Sense of Spreading Our Eggs

The Ultimate Investment Club

Own the Entire World, Starting with the United States

Next, Own the Rest of the World

Own the Entire Bond Market

The Final Lesson: Think Long-Term

Finally, We Build the Portfolio

Is The Second-Grader Portfolio Right for You?

A Couple of Alternatives

Chapter 3: The Advantage of Having Wall Street Marketing Blinders (and Where Can I Get Some?)

The Common Sense of the SpongeBob Strategy

Marketing: The Auto Industry versus Wall Street

Why We Keep Playing a Game We Can’t Win

Get Real

The Wall Street Game and the Sad Results

The Story of Headline News: Active Beats Passive!

The Secret of Kevin’s Immunity to the Wall Street Illusion

Applying the SpongeBob Golden Rule

Chapter 4: Adults Behaving Badly

The Common Sense of Good Money Behavior

Fear and Greed—Buying High and Selling Low

Behold the Brilliance of Hindsight

Forget Everything You’ve Heard About Optimism

The Curse of Overconfidence

Data Mining to Find Patterns in Randomness

Anchoring to Something Meaningless

Framing a Problem to Confidently Reach a Wrong Conclusion

Mental Accounting Always Adds Up to What You Want

Confirmation Bias: Everyone Has a Right to My Opinion

Heuristic Biases Get in the Way of Performing Even Simple Tasks

A Tale of Silly Human Behavior

Chapter 5: Can You Beat a Second Grader’s Portfolio?

The Common Sense of Avoiding Bad Bets

The Performance of Kevin’s Portfolio

Odds Are You Don’t Know the Odds of Your Portfolio

Comparing an Active Portfolio to an Index Portfolio

I’m Not Done Yet—The Odds Are Even Worse

Why We Make Those Sucker Bets We Have a 99 Percent Chance of Losing

How the Odds Play Out in the Real World

Chapter 6: Beyond the Second-Grader Portfolio

The Common Sense of Not Explaining Correlations to an 8-Year-Old

The Importance of Being Negative

What Kevin Has Already Done Right

Using Correlations to Go Beyond the Second-Grader Portfolio

The Sophisticated Portfolio I Couldn’t Convince Kevin to Buy

Chapter 7: Bonds—Your Portfolio’s Shock Absorber

The Common Sense of Lending Money to Someone Who Will Pay You Back

Two Types of Risk in the Bond Market

Putting the Two Risks Together

Bond Mutual Funds and ETFs Are Better Than Bonds Themselvesn

Are We Forgetting International Bonds?

Buying Bond Funds

Chasing That Little Extra Yield

Chapter 8: Better Than Bonds

The Common Sense of Lending Money If It’s Backed by Someone You Trust

The U.S. Government Created Inefficiency in Fixed Income

The Value of This Market Inefficiency

Why These Attractive Rates Exist

Why These Above-Market Rates Last So Long

What to Look for in a CD

Enough Theory—Where Do I Find These Great CDs?

What Can Go Wrong?

Is It Worth the Trouble?

Have I Committed Heresy?

Chapter 9: Simply Brilliant or Brilliantly Simple—Building Your Portfolio

The Common Sense of Holding on to Your Lunch Money

How Much Risk Is Right for You?

What’s Your Willingness to Take Risk?

What’s Your Need to Take Risk?

Risk and Your Asset Allocation

What about Investments That Give the Best of Both?

How Many Eggs Do I Put Overseas?

What Portfolio Allocation Is Right for You?

Getting to Your Allocation

Rebalancing the Portfolio: Market Timing That Actually Works

Chapter 10: Investors Who Love to Pay Taxes, and the IRS Who Loves Them

The Common Sense of Not Paying More Tax Than You Have To

Asset Location, Location, Location

Chapter 11: Nightmare off Wall Street—The Scary Tale of Trick-or-Treat Investing

The Common Sense of Staying Away from Something Too Good to Be True

Insurance Investing Is Great—For Your Agent, That Is

Investment Newsletters

Investor Education and Software

Hedge Funds

Avoid Gurus Giving Self-Serving Advice

Chapter 12: Increase Your Return No Matter What the Market Does

The Common Sense of Picking the Low-Hanging Fruit

Where to Find Low-Hanging Fruit

The Mother of All Low-Hanging Fruit: Asset Location

Other Sources of Low-Hanging Fruit

Chapter 13: Keep It Simple, Stupid (KISS)

The Common Sense of the KISS Principle

Simple Investing Isn’t Easy

It’s Okay to Have a Little Fun

Write a Contract between You and Your Money

My Parting Words to Wall Street: “Thank You!”

Never Forget the Purpose of Money

Kevin’s Postscript

Notes

About the Author

Index

Additional Praise for How a Second Grader Beats Wall Street

“I have a very strong feeling that sometime in the not-to-distant future I will happily be working for Allan Roth’s son! If you buy only one how-to book this year, this is the one! Allan Roth is a National Treasure.”

—Mike Causey, senior correspondent, FederalNewsRadio.com

“Allan presents in a very clever way why a second grader can outperform most investors, professional and individual. He demonstrates why smart investing is both simple and also why it is not easy for adults to execute because of behavioral mistakes to which they are prone.”

—Larry Swedroe, author of Wise Investing Made Simple

“Successful investing should be a matter of choice, not chance. Follow this book’s advice and your probabilities of success are 100% in your favor.”

—Paul Merriman, author, Live It Up Without Outliving Your Money! (Wiley), and publisher of FundAdvice.com

“Allan Roth gets an A+. It is no surprise that a 2nd grader beats Wall Street because everything we need to know about beating the pros is taught in the first grade. That is when we learn to add and subtract. And after subtracting the high fees and commissions that the pros charge, their results fall far short of a simple market return.”

—Richard Ferri, CFA, investment advisor and author of The ETF Book

“Pablo Picasso spent a lifetime learning to paint like a child. Investors might be wise to do the same. Allan Roth’s How a Second Grader Beats Wall Street reminds us that the most important investment principles are actually simple truths that we lose sight of as our lives and investment approaches grow more complicated. By returning to the basics, we can both simplify our finances and improve our investment results.”

—Don Phillips, Managing Director, Morningstar, Inc.

“Allan Roth shatters the Wall Street myth that investing is too complicated for ordinary investors. Using his son, Kevin, as an example, Allan shows us, in his easy-to-read writing style, how we can construct a simple personal portfolio that is almost certain to outperform the vast majority of investors. If you have been looking for an easy-to-understand book about how to invest successfully—this is it.”

—Taylor Larimore, co-author of The Bogleheads’ Guide to Investing

“Using just a bit of logic and a dash of arithmetic, Allan Roth lucidly explains why low-cost index funds should be the investment of choice for 2nd graders as well as their parents and grandparents.”

—John Allen Paulos, mathematics professor at Temple University and the author of Innumeracy and A Mathematician Plays the Stock Market

“Kevin, the second grader, is really smart and cool! He knows what it took me decades to learn. A smart strategy is to diversify broadly across US stocks, international stocks and high-grade US bonds using low-cost, tax-efficient index funds. He even taught me how individuals can increase their fixed-income returns without incurring higher risks. By following Kevin’s advice, we, too, can be smart investors. But we may never be as cool as Kevin!”

—William Reichenstein, Powers Chair in Investment Management at Baylor University

Copyright © 2009 by Allan Roth. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

Data ©2008 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; (3) does not constitute investment advice offered by Morningstar; and (4) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Use of information from Morningstar does not necessarily constitute agreement by Morningstar, Inc. of any investment philosophy or strategy presented in this publication.

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Library of Congress Cataloging-in-Publication Data:

Roth, Allan S., 1957-

How a second grader beats Wall Street: golden rules any investor can learn/Allan S. Roth.

p. cm.

Includes bibliographical references and index. ISBN 978-0-470-37594-5 (cloth); ISBN 978-0-470-91903-3 (paper); ISBN 978-0-470-45484-8 (ebk); ISBN 978-0-470-45515-9 (ebk); ISBN 978-0-470-45516-6 (ebk)

1. Portfolio management. 2. Index mutual funds. 3. Investments. I. Title.

HG4529.5.R67 2009

332.6–dc22

2008041525

To investors, like my son, Kevin, who know the truth of simple arithmetic

Foreword

I don’t know about you, but I wouldn’t go to a doctor who smoked. I also wouldn’t use a personal trainer who looked like he gorged on fast food or a trial lawyer who lost most of her cases. I’m sure you don’t find any of these views surprising. Here’s what is: Over 90 percent of individual investors rely on brokers or financial advisers who tell them they can “beat the market.”

It doesn’t seem to matter that the objective evidence demonstrates this expertise doesn’t exist with any persistence. In fact, on average stock market investors obtained only about 40 percent of market returns over the past 20 years because they relied on these so-called investment professionals.a However, the fact is that achieving full market returns, less low fees, is yours for the asking.

There seems to be an overwhelming case of national cognitive dissonance when it comes to evaluating the merits of brokers. The brokerage industry participated in the bankruptcy of Orange County, California. It cost investors trillions of dollars when technology stocks crashed. It was exposed as participating in a massive fraud on its retail clients in the analyst scandal. Of course, all this pales when compared to recent events.

Wall Street as we knew it no longer exists. Bear Stearns and Merrill Lynch were sold to avoid total collapse. Lehman Brothers went bankrupt. The balance of the industry had to be bailed out by the U.S. Treasury. Hundreds of billions of dollars were lost by these firms through reckless trading in the subprime debt crisis. Merrill Lynch alone lost a whopping $50 billion in this mess. It couldn’t be more obvious: They couldn’t manage their own finances. Why are you letting them manage yours?

I have yet to discuss the really compelling reasons for staying away from this industry.

They can’t pick stocks. They can’t time the markets. They can’t pick mutual funds that will outperform other funds. And this is their daily grist!

I am not asking you to take just my word. A recent study showed past performance is not predictive of future performance of a mutual fund.b Another study showed that, when actively managed funds (funds where the fund manager attempts to beat a given benchmark) do outperform, the explanation is more likely luck and not a measurable skill.c

The advice of the authors of this latter study was simple and direct: Investors should “want low-fee, passive funds, unless you feel like paying these active managers the fees for basically not having performance that can be documented.”

Maybe the problem is that the ramifications of this data are just too large for most investors to accept. Could it really be that an entire industry is premised on a skill that does not exist, and its advice is being aggressively sold to gullible investors who desperately want to believe it does?

Many of us have done our best to expose the con: Burton Malkiel’s seminal book, A Random Walk Down Wall Street, makes an irrefutable case, but the book is too technical for mass consumption. John Bogle, the founder of Vanguard, did an excellent job of distilling the facts in The Little Book of Common Sense Investing. I did my best to make it even simpler in The Smartest Investment Book You’ll Ever Read.

All of us had a lot of data, which fueled our passion. After all, in addition to hundreds of academic studies, Nobel Prize–winning research was on our side. Nobel Prize winners like Merton Miller, Paul Samuelson, William Sharpe, and Daniel Kahneman all support these views. Still, it felt like we were dropping a pebble into the ocean. The mega-marketing machine of the securities industry churned on, extolling the views of its analysts, talking up “target prices” of stocks and the ease with which investors could conduct their own research and engage in active trading. Never mind that there is no evidence that any amount of research will permit investors to beat the markets with any consistency; never mind that trading increases costs, which reduce returns.

The appeal of frenetic activity and diligence as somehow being related to superior returns is fueled by the financial media. We see breathless reports from the New York Stock Exchange that reinforce the false and discredited notion that investors must pay rapt attention to minute-by-minute breaking financial news, lest they miss out on a valuable trading opportunity. Internet news sites are filled with stories about “five stocks to buy to protect you from the coming depression” and “10 reasons to buy gold now.” Investors are led to believe that some call to action by a self-styled investment guru is actually a rational way to invest.

As Dr. Phil would say: How is this working for you?

Not very well. Investors lost trillions of dollars in the recent market crash. Not coincidentally, brokers en masse had a conversion to a new investing philosophy: fleeing to safety. Americans abandoned their love affair with stocks in droves, just in time to miss the impressive run-up in the Standard & Poor’s 500 in 2009. Investors, guided by their self-styled gurus, are a day late and a dollar short.

No wonder Americans are in such desperate shape. Foreclosures are at record levels. Average 401(k) balances are so low they would not fund one year of expenses, much less the vaunted “retirement with dignity” we so desperately want. There seems to be no end to the bad news. What’s next? A global depression? Faced with the worst financial crisis in 50 years, investors yearn for sanity and clear, levelheaded thinking and analysis.

Enter Allan Roth, with his wonderful and insightful book, How a Second Grader Beats Wall Street. This isn’t a book about a precocious child (although I suspect Kevin is genetically privileged). And it’s not as if Allan doesn’t have the ability to come up with a complicated investment scheme that would knock your socks off. Not only is he one of the smartest people I know, but he has the credentials that give him real credibility (both a CPA and an MBA degree).

This is a book that validates Albert Einstein’s famous quote: “If you can’t explain it simply, you don’t understand it well enough.”

There is no doubt that Allan understands investing more than “well enough.” It doesn’t get much simpler than this for expressing two golden rules of investing:

1. Embrace simplicity.

2. Stop acting silly with money.

Viewed through the eyes of a second grader, Allan gives us insight into the craziness that passes for investing. Here are some poignant examples:

We know it’s best to buy what we want when it’s on sale, yet we buy stocks when prices are high only to sell when they plummet.We know we shouldn’t put all of our eggs in one basket, yet we pile our basket sky-high with too many of whatever stocks have recently been popular.We play games with our money that we have little chance of winning—less than a 1 percent chance, as a matter of fact.We tell our children not to trust strangers, yet we trust strangers from Wall Street to help us.We seem to love to pay unnecessary taxes.

Of course, at the end of the day, it’s results that count. I have a relative whose wife explained to me that he didn’t need to read any books on investing because he “had a feel for the market.” This was during a bull market when if you threw a dart at a stock you hit a winner. He lost most of their retirement savings when the markets swooned. The “feel” turned out to be fleeting.

The investing principles set forth in this book worked great when the markets were going gangbusters. How did they do when the markets tanked? Even better!

Since the end of 2007, when the stock market closed the year at an all-time high, Allan’s basic moderate portfolio (60 percent equities) is 2.3 percent above the pre-crash 2007 year end levels as of mid-October. His conservative portfolio (30 percent equities) gained 9.5 percent. Even his aggressive portfolio (90 percent equities, appropriate for someone with an extremely long time horizon) lost only 9.5 percent. Both the moderate and conservative portfolios are even above the all time high of the stock market which occurred on October 9, 2007. Throwing in a couple of alternative investments improved performance even more.

Compared to most professionally managed portfolios, the simple principles espoused in this book worked even better in bad times than their outstanding performance in good times.

Better returns are not the only reason this book is a significant contribution to investors. By demystifying investing, Allan empowers investors to take control of their finances and to avoid becoming another victim of the securities industry. Investors who adopt these simple, easy-to-implement investing rules will achieve peace of mind, knowing they are in control of their money, rather than having the markets and their brokers control them.

Don’t be misled by the title of the book. Investing is not easy, largely because the securities industry has a vested interest in keeping you confused, fearful, anxious, and misinformed. Fight back with the wise advice in How a Second Grader Beats Wall Street. You’ll be glad you did.

Daniel R. Solin

October 2010

awww.dalbar.com/Portals/dalbar/cache/News/PressReleases/pressrelease 20100331.pdf.

b As reported by Time magazine. Available at: http://curiouscapitalist.blogs.time.com/2010/06/21/investing-does-past-performance-matter/?xid=rss-topstories.

c As reported by U.S. News & World Report. Available at: http://money.usnews.com/money/blogs/Fund-Observer/2010/6/24/just-how-lucky-is-your-mutual-fund-manager.html.

Acknowledgments

Writing this book has been the closest thing to what I imagine childbirth is like to experience. From the excitement of getting the contract and advance, through months of discomfort, nausea, and maybe even a little weight gain from stress eating, all the way to the pain of bringing forth the finished product. As I reflect on this process, I know with certainty that I would never have gotten through it without an immense amount of support.

This section must first start with my deep appreciation to a legend—Jack Bogle, who did three things for me. First, he brought us all the tool to make competing with Wall Street an unfair game—the broad low-cost index fund. Next, by using his tool and harnessing the power of compounding, I accumulated enough funds to leave corporate America and pursue my dreams. Finally, he provided me with encouragement and guidance in the pursuit of my own little cause—to stop the flow of funds from the consumer to Wall Street.

Jack Bogle is a legend, but no legend exists without help. Jack’s right-hand man, Kevin Laughlin, does so much to help the Main Street investor. He has given me years of wisdom and pored through earlier versions of this manuscript suggesting countless changes that have made this book much better. In many ways, Kevin wrote this book with me. Jack’s small team does a great deal for us consumers.

Another special word of thanks goes to Paul B. Farrell, columnist for DowJones/MarketWatch and author of some of my favorite books. Paul’s seven “Lazy Portfolios” were developed by some of the most brilliant and successful investors in the United States. Imagine the proud dad I was when he added my son’s portfolio as the eighth. Paul, you understand the brilliance of simplicity.

Writing is difficult for a left-brained math geek like me. I was encouraged by people who, not too long ago, were total strangers. Some of my favorite and most respected writers befriended me and gave me constant encouragement. These include Jonathan Clements, formerly of the Wall Street Journal, and Jason Zweig, who replaced him. Eric Schurenberg, managing editor of Money magazine, has taken the time to read my work and has helped me to develop as a writer. Other brilliant writers like William Bernstein and Dan Solin have generously given me the benefit of their experience and guided me through the process.

I would never have become a writer had it not been for Mike Boyd and the great people at the Colorado Springs Business Journal. Mike asked me to write a column for the paper, and I thought it would be fun to do for a few months. That was about five years ago and I’m still writing.

Other media types have also contributed greatly. Jeffrey Pritchard, who writes a wonderful blog, AllFinancialMatters.com, has helped me enormously. Mike Causey of Federal News Radio is a kindred spirit and constantly preaches the brilliance of simplicity.

I’d like to express appreciation to my talented friend, Laurie Anderson, who developed the illustrations in this book. In my view, a picture is worth a thousand words, and her graphics make this book much more powerful. The Colorado Springs Business Journal was also generous in allowing us to base some illustrations on their work. Venkat Reddy, the dean of the College of Business at the University of Colorado at Colorado Springs, taught me to teach. These skills have been critical in writing this book.

I appreciate all of the help from the good guys in investing, and I must also make mention of the countless friends and clients who gave of their time to read this manuscript. I’ve been poisoned with all of the financial jargon of the industry and needed them to point out where I was using psychobabble that had meaning only for us professionals. Dozens of people, like Jeff Hundt, Charlie Rollman, and Steve King, helped me make this closer to a jargon-free book.

I often learn more from people I disagree with than from those who share all of my views. For this reason, I’d like to thank Marv Tuttle, CEO of the Financial Planning Association. His ability to deal with dissent by keeping the dialogue continuing in a productive way is something I will always strive for.

By far the largest data source for information in this book was Morningstar, Inc. Their assistance and ability to turn large amounts of data into simple, understandable information helps investors make better decisions.

My publisher, Joan O’Neil, and everyone else at John Wiley & Sons have been wonderful to work with. I am deeply grateful to my editor, Bill Falloon, for his willingness to take a big chance with a first-time author, as well as his superb editing. Emilie Herman, development editor, and Laura Walsh, associate editor, have always had time to walk me though the process and have given me great ideas now incorporated in this book.

While I started by acknowledging Jack Bogle, I must end by thanking my family, because writing this book was truly a family affair.

I want to thank my son, Kevin, first and foremost, for all that his very presence has brought to my life. Becoming a dad in midlife has definitely proven to me that the old adage “better late than never” holds water. I would also like to thank Kevin for listening to his old dad give investment lessons, and actually enjoying them. He in turn gave me some important lessons that made me realize the ways in which I made things more complicated than they needed to be. But most of all, I want to thank Kevin for all the ways he makes his dad so proud.

Finally, no one has done more to make this book happen than my wife, Patty. Not only has she put up with me and supported me for the past couple of decades, she has helped me every step of the way in writing this book. She is a brilliant writer and has edited every single page in this book, as well as every article I have published. I believe this book comes alive because of her. Living with me is hard enough, so also working with me qualifies her for sainthood. I am indeed a lucky man.

Introduction

The Seeds of Financial Success

Throughout history, wiser individuals than I have extolled the virtues of the child’s perspective. Be it religion, society, or, in this case, investing, there are lessons we adults can learn from the uncluttered and uncomplicated minds of children.

In How a Second Grader Beats Wall Street, we’ll look at what the uncluttered mind of my second-grader son, Kevin Roth, was able to accomplish with some money from his grandparents and some direction from his dad. We’ll explore some simple techniques that can work wonders in your own portfolios, such as moving up financial freedom by 10 years or more. That’s a decade closer to pursuing whatever makes you happy. And you can do it by cutting through the baloney that Wall Street wants us to believe and returning to basic simplicity.

It all started when Kevin was still in kindergarten. I set a goal that by the time he was in second grade, I would teach him to build and maintain an investment portfolio that would beat Wall Street. I’ll confess that I didn’t consider this to be a daunting challenge at the time. In fact, I actually thought I had set the bar pretty low. This was Wall Street, after all, home of the “new age economy” of the 1999 tech bubble and “AAA-rated risk-free subprime mortgage notes.”1 As Warren Buffett put it “First, many in Wall Street—a community in which quality control is not prized—will sell investors anything they will buy.”2 Well, Kevin and I did design the portfolio in second grade and it did beat the professionals of Wall Street. Paul Farrell, of Dow Jones MarketWatch, now includes Kevin’s portfolio in his list of eight “lazy portfolios” that consistently beat Wall Street. The second-grader portfolio is side by side with some of the world’s best investors, such as David Swensen, chief investment officer of Yale University’s endowment fund, and William Bernstein, investment advisor and author of many great investing books, including one of my favorites, The Four Pillars of Investing (McGraw-Hill, 2002). You can see all these portfolios and their current performance at www.marketwatch.com/lazyportfolio.

It was not the success of Kevin’s portfolio that surprised me, as he merely used the simple principles that consistently work in investing. What did surprise me were the large advantages that a kid has over an adult when it comes to investing. What started out as a journey to teach my son simple principles of investing instead turned into an incredible joint learning experience. And what I learned is that everything we need to know about investing, we’ve learned by second grade. It’s what we learn after second grade that turns out to be so destructive.

Before we get to that, let me first give a little background. Five days after my wife Patty turned 40, with me four months behind her, we learned she was expecting our son. At this point in our lives, we figured the ship had sailed on having children and that maybe we would do like many of our friends and get a couple of dogs to give our cat, Hoover, some siblings. We were sure we would be the oldest couple at our natural childbirth class, but we weren’t. In fact, we were simply part of a growing social trend known as GWK, or Geezers with Kids.

There is an interesting shift in the family dynamic that occurs when an only child is born to middle-aged parents. We’ve often felt like some hybrid of a parent and a grandparent. I certainly don’t remember my parents regularly getting down on the floor and playing with me as parents do now, nor do I remember being included in things that were considered to be adult territory. But strangely enough, Kevin and I have found a mutual interest in the adult territory of investing. In fact, it is his uncomplicated perspective on something that we adults have made very complicated that has provided me with a wonderful window on the power of a fresh perspective.

For starters, money is obviously more critical to adults than it is to second graders. To a child, money is only as important as what can be bought with it. It’s a means to an end—something that’s used to obtain candy or a new video game. Adults care about money in a material and an abstract sense; historically, we adults have placed enormous value on accumulating as much of it as we can. To us, money is a new house or car, but it is also freedom or security. In addition to that, adults are barraged constantly with helpful “expert” advice on the next hot investment, so as to increase our supply of money. Accordingly, we take all of this knowledge, apply what we believe to be thoughtful analysis, and somehow manage consistently to outsmart ourselves. Yet we don’t learn from our investing mistakes, and that pretty much guarantees we’ll continue to repeat them. This book will delve into the silly behavior we adults seem hell-bent on repeating, even though it only leads to sabotaging our retirement.

Just as an example, we adults tend to follow the herd, thinking there is safety in doing what everyone else does. We bravely invest in the stock market after a bull market and then panic and sell after the bear arrives. Kevin, on the other hand, doesn’t even have a clue that the investing herd exists, let alone want to follow it. That’s a huge advantage over you and me.

Together, Kevin and I developed some “golden rules” about investing. These rules will help anyone to unlearn some of the things we think we know about investing. By following the golden rules presented in this book, we can simplify our thinking and stop doing the things that needlessly set our financial goals back.

What will these golden rules do for you?

1. Show you why the debate between active and passive investing is just plain silly.

2. Move up your financial independence by a decade, and dramatically increase your spend rate during retirement.

3. Show you how to go beyond indexing, which owns the entire market, and actually beat the market by using the one advantage the small investor has over the large institution. Yes, we have an advantage in fixed income!

4. Show you how to reengineer your portfolio so it will be more tax efficient, because your portfolio is probably designed backwards, causing you to pay taxes needlessly. A little portfolio reengineering can save a bundle.

5. Give you a simple tool that, in a couple of minutes, will allow you to know whether a product with a 447-page disclosure document has something in it for you.

6. Guide you to the low-hanging fruit in your portfolio that is likely sitting right in front of you. It’s a sure way to increase returns whether the market goes up, down, or sideways.

7. Show you that common sense isn’t all that common and how you can profit from second-grader logic.

8. Assist you to unlearn what you know about investing and be able to think in the crisp terms that only a child can.

9. Make you feel better about paying the high price of gasoline. Many of us can save more from investing than we could from winning free gasoline for the rest of our lives.

10. Help you understand why we owe a great debt of gratitude to active investors and Wall Street.

It is my hope that this book will provide you with many aha! moments that will bring a clarity to your investing that may increase your long-run return by 4 percent annually or more! I also hope you will realize that common-sense investing isn’t actually all that common.

What This Book Is, and Is Not

This book isn’t about a kid who either got lucky or did anything complex in investing, or who is a prodigy of some kind. Kevin’s success had nothing to do with luck or brilliance, and everything to do with simplicity and low cost. His U.S. stocks beat Wall Street, and so did his international stock portfolio and his bond portfolio. The most important thing, however, is that they must continue to do so. It’s a mathematical certainty.

Neither is this book one of those self-discipline books about spending less today so you can have more tomorrow. Don’t get me wrong; I happen to believe that this is an essential part of reaching your financial goals. Saving, however, involves giving up some immediate gratification, such as not buying that big-screen HDTV, in return for having more later on in life. Like dieting, saving involves making some sacrifices.

What this book is about is building up wealth without having to make additional sacrifices. As long as you have money to invest, this book is about making it grow. Not at the long-term rate you’ll get from the vast majority of Wall Street’s highly paid financial wizards, but at a real (inflation-adjusted) rate that will double or triple it.

What do you have to sacrifice now for that faster growth? Absolutely, positively nothing! In fact, a sign that you are doing it right is that you find yourself with more free. And if a second grader can explain the logic, it’s something all of us have the ability to do; we just need the willingness to apply some simple logic to question what we are currently doing.

Kevin’s Accomplishments—Kid Handily Beats the Street

In Wall Street speak, Kevin designed a portfolio that beat the S&P 500 by 4 percent annually. In fact, in 2007, he earned nearly 2.5 times the S&P 500 index. Most Wall Street firms would be thrilled to have this performance, but few firms ever will. As long as the laws of simple arithmetic hold, Kevin’s portfolio will continue to outperform Wall Street:

Over the two-year period, his portfolio has grown 34.1 percent, which equates to a 15.8 percent annual return, according to Morningstar.3He bested the S&P 500 common benchmark by 2.23 percent annually, and did so with less risk.Kevin’s portfolio joined the eight portfolios Paul Farrell tracks that include billion-dollar portfolio managers, famous authors, and money managers—some of the world’s best investors.

Most high-performing portfolios take a lot of risk. Not this one. The securities in the second-grader portfolio take on far less risk than the portfolios of the Wall Street firms. The second-grader portfolio doesn’t use sophisticated risk-management techniques to outsmart the market. Those same sophisticated techniques led to hundreds of billions of dollars of Wall Street losses and the collapse of Wall Street icons like Bear Stearns, Lehman Brothers, Wachovia, and AIG.

How did Kevin do it? It depends on whom you ask. Let’s take a look at a couple of different explanations.

Wall Street Explanation

If Wall Street had designed this portfolio, it would say it used modern portfolio theory to design a portfolio on the efficient frontier that beat the S&P 500 index by 4 percent annually. Furthermore, the portfolio was designed to provide a superior risk-adjusted return as measured by the Sharpe ratio, with a lower standard deviation than the market. The portfolio was built by using thousands of underlying securities, screening for different asset classes with low correlations with each other, and stock styles that do not always move in tandem. It utilized the teachings of Nobel Laureates in economics such as Harry Markowitz, William Sharpe, and Daniel Kahneman. The portfolio takes the essence of their findings and applies them in a practical manner that is quantifiably guaranteed to outperform other investors. Some of these theories are complex, but they end up being incredibly simple to implement.

Kevin’s Explanation

While the Wall Street explanation sounds impressive and complex, the truth is that Kevin accomplished this by using simple common sense and a little second-grade arithmetic. His magic portfolio is simply:

Vanguard Total Stock Market Index Fund (VTSMX)60%Vanguard Total International Stock Index Fund (VGTSX)30%Vanguard Total Bond Market Index Fund (VBMFX)10%

Exhibit I.1 Annualized Performance of Second-Grader Funds

With these three funds, you can own virtually the entire global equity market and the U.S. investment-grade bond market. Now, this portfolio certainly isn’t right for everyone, but a version of it with different allocations should be the building blocks for most investors. We just have to resist adding in too many additional blocks.

These funds earned quite respectable long-run returns in a time when the stock market resembled a rollercoaster. They survived the Internet bubble, and the subprime mortgage fiasco, as well as Enron’s and WorldCom’s (Exhibit I.1).

How has the portfolio done versus the S&P 500 index? Look at Exhibit I.2 and judge for yourself.

Exhibit I.2 The Second-Grader Portfolio Handily Beat the S&P 500 Index in Every Time Period

As I finish this book, the market is clearly in bear territory and the numbers above have deteriorated. The impact of the subprime mess ended up being more devastating and far-reaching than we could have ever anticipated. And clearly, Kevin’s portfolio is down. In Kevin’s short life, he has experienced the Internet bubble where cash supposedly didn’t matter, and years of easy credit where we lent trillions of dollars to people who never had a prayer of ever paying it back. Keep in mind, however, that the advice in this book is even more valuable in down markets because:

Kevin’s long-term performance versus the S&P 500 index has actually increased during this down market.Kevin is unlikely to panic and sell, as many investors do. He has other things on his mind besides his portfolio. This gives him a huge advantage that we should try to emulate.Kevin is able to buy in at lower prices. Unlike many adult investors, he likes to buy when prices are low.

Yes, Kevin’s portfolio is down, but he’s not watching the talking heads on television and following an aged-old adult tradition of panicking and selling low. He’s not rationalizing how “this time it’s different.” In fact, Kevin rarely thinks about his portfolio. This is an advantage that his dad, and all of us adults, will find hard to replicate. And even Kevin will lose this advantage as he grows up.

How does Kevin beat the S&P 500 index in any market? For now, I’ll just leave you with the hint that Wall Street likes to compare its performance to the S&P 500 index because it’s not the entire market. In fact, it’s not even the total return of a portion of the market.

Of course, there is much more to this book than simply talking about three funds. There are alternative funds to use as building blocks that have lower costs and even more diversification. These are some risky asset classes that may actually decrease the overall risk of our portfolio. If you are willing to do just a little work, you can even replace the bond fund and bump your return while lowering risk. Finally, there are some things you can do with this portfolio that will increase return no matter what the market does.

Successful use of this book means increasing your returns by 3 to 4 percent annually. This may not sound like much, but each 1 percent may, on average, move your financial goals up by four years (much more on this in Chapter 13). We are talking about giving you 12 to 16 years of your life to pursue whatever it is that makes you happy. And if you are already retired, the wisdom of a second grader can increase the amount of your portfolio that you can safely spend by as much as 50 to 70 percent annually! Both Jack Bogle and Albert Einstein talk about the power of compound interest; this book will show how harnessing this power can simply change your life.

Reading this book will show you that investing isn’t rocket science. Wall Street experts want you to believe that it is, so you will be dependent on them and fund their lavish lifestyles. This book will show you how to cut the cord that transfers our wealth to Wall Street. For those who don’t believe simple is better, remember that both Albert Einstein and Sir Isaac Newton, considered to be perhaps the two smartest humans in history, were known to state that brilliance lies in simplicity rather than complexity.

Get ready to unlearn all of the psychobabble you’ve been taught regarding investing. Our second grader will show you how to replace it with simple common sense. And we will show you why common sense isn’t actually all that common.

Embracing the simple second-grader wisdom will shield you from the “helpers” that I call Wall Street that merely want to transfer your wealth to them. And by Wall Street, I mean everybody who’s after your money, not just the large brokerage houses. I’ve seen many independent planners, insurance companies, and mutual fund companies do things that make me cringe. They all share one thing in common: They fail to pass a simple smell test from a second grader.

If you are successful in applying the golden rules in this book, you will achieve your financial goals far sooner than you imagined. That alone is a pretty good reason you should give it a try. But let me offer a word of caution: Simple investing is really easy for a second grader, but not so easy for us adults. We have to overcome something even more likely to rob our wealth than Wall Street. We have to overcome our own emotions, because our emotions consistently steer us toward the path that leads only to giving away our hard-earned nest egg.

I hope you enjoy the simplicity and messages from the pages that follow. Much of the wisdom lies in the beginning of each chapter describing a conversation with Kevin. The 13 conversations were actually compiled from many more than that and condensed down. I also have taken a bit of creative license with them to better illustrate how simple it is to be a successful investor.

As you read this book, remember the phrase, “Simple investing isn’t easy.” Good luck in your process of unlearning the many complicated mental models that we have all blindly accepted as true.

Disclaimer and Data: “Why Do We Need This, Dad?”

Why do we need this? Well, primarily because we live in a litigious society. Even in a book about simple investing, you never want to leave home without the proper disclaimers. Therefore, in the interest of disclaiming, I have done my best to accurately capture information and offer advice that I believe will work for most people, if they dare to implement it. None of the advice, however, takes into account the individual reader’s specific circumstances and should not be taken as such. As there is nothing simple about taxes, and though I touch on taxes in this book, seeking proper expertise on your individual situation is strongly, and I mean strongly, recommended. In short, getting into a simple portfolio is easy, but getting out of a complex portfolio is not. I always recommend gaining a full understanding of any investment product purchased and the entire long-term investment strategy.

Throughout the book, I’ve listed data sources in the text and on the graphics. Morningstar has provided much of the data. All data is believed to be accurate, but such accuracy is not guaranteed. And, of course, past performance is no guarantee of future performance.