beginner mistakes

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ETFInvestor Newsletter

Failing to Understanding the Basics

Defying common sense, some investors believe that they can be very successful

without having a deep base of knowledge, as if ignorance were a badge of honor.

The best you can reasonably expect with a weak grasp of the basics is to get

lucky--either you put your money in the hands of someone who happens to be

good, or you get lucky yourself and own things that go up in value.

There are certain concepts that an investor must understand to do a passable job

investing. One is statistics and probability. An advanced level of knowledge isn't

required, but it is essential to have an intuitive understanding that investing is a

statistical exercise, where the luck of the draw dominates day-to-day, even

year-to-year outcomes. Without feeling and knowing this fact down to your toes,

you're liable to do silly things like react to noise generated by the market.

The other important topics include financial history, the incredible difficulty of

forecasting the future, the ways humans are wired to misbehave, and so forth. I'm

not going to go over them all. Needless to say, the basics encompass a body of

knowledge that's at least book-length. If you're shaky, please buy a good book. I

recommend "The Investor's Manifesto" by William Bernstein. I'm probably one of

the few newsletter editors who'll encourage you to buy a book that, well, advocates

not heeding to any newsletter. Bernstein is even more of a curmudgeon than I am

and is actually somewhat distrustful of exchange-traded funds. (I hope you'll makea teeny-tiny exception and come back.)

Basic Strategy

I know I sound terribly self-interested, but I believe investing in low-cost index

funds, a group that contains lots of exchange-traded funds, is one the best ways to

avoid making big mistakes. ETFs are cheap, diversified, and tax-efficient. For the

most part run by computers (with a helping hand from humans), they avoid many

of the wedges that separate the interests of fund managers and shareholders.Index funds simplify the task of investing mainly to understanding and applying

the basics of asset allocation. If you don't have the energy to manage your

investments full-time, giving the task of trying to beat the market the respect it

deserves, I believe that it would be a mistake to not invest much of your portfolio

in them.

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Disclosure: Morningstar, Inc.'s Investment Management division licenses indexes to financial institutions as the tracking indexes for

investable products, such as exchange-traded funds, sponso red by the financial institution. The license fee for such use is paid by the

sponso ring financial institution based mainly on the total ass ets of the investable product. Please click here for a list of investable

products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets,

sells, or makes any representa tions regarding the advisability of investing in any investable product tha t tracks a Morningstar index.


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Boomer165

Jan 10 2014, 6:00 AM

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Great writing Sam. I have found you to be one of the best writers

I've read over the last 30 years. Please keep doing what you are

doing.

sevendzboy

Jan 9 2014, 11:45 PM

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Great article. Sam - you seem wise beyond your years.

Understanding one's self and trying to control investment emotions

within a personal investment plan takes many years - you have

provided a great framework for readers here IMO.

Lengrav

Jan 9 2014, 11:22 PM

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Love your writings. I to am a Bernstein fan. I give the book

mentioned to new clients. I buy a dozen at a time. I'm a cpa.

yogibearbull

Jan 9 2014, 1:57 PM

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ETFs can trade in-kind w/o any tax implications. So they can kick

out lowest cost shares first, thus reducing future tax liability.Indexed OEFs are quite tax efficient, but indexed ETFs can be even

more so.

mrpcid

Jan 9 2014, 12:59 PM

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Useful article.

"I believe investing in low-cost index funds, a group that contains

lots of exchange-traded funds, is one the best ways to avoid making

big mistakes. ETFs are cheap, diversified, and tax-efficient."Is it also true that low-cost index ETFs are more effective than

similar lost cost index open-ended funds?

Thanks

philodough

Jan 9 2014, 10:50 AM

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Sam - Good article as always. I enjoy reading your articles. There is

a grain of truth to capecod's statement - but so what - it comes with

the territory. When you start your own bridgewater let us be the

first investors.

I think the interesting question is how do you get over the investing/

Beginner Mistakes http://news.morningstar.com/articlenet/article.aspx?id 624997

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cost of living issue. My Grandfather dollar cost averaged from the

1930s. Investing should be for the long term - but in the long term

were all dead. Investing is like watching paint dry. Like Bogle said in

one of his first books buy 15-30 quality blue chip stocks and hold

forever.

I guess the real question is how do you get your grub stake? Its

very hard for the average person to live off 4% of their portfolio. I

know the average person doesn't have a portfolio :)

felix

Jan 9 2014, 7:20 AM

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Thank you Sam for another helpful article. I don't detect any

"snootiness" or "self obsession." You are addressing a fact that is

rarely discussed by financial analysts, which is that throughout

history many people have lost significant amounts of moneyinvesting in the market. Some have lost their savings, their houses,

and their retirement income. I would guess that almost any poster

at M* knows either a friend or family member who has suffered this

fate. Keep these heartfelt and thoughtful articles coming. IMO they

are among the best that M* has to offer.

SAM19454

Jan 9 2014, 6:07 AM

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rockymountians

With all your money and knowledge--why the hell are you, usingyour valuable time here?

rockymountains

Jan 9 2014, 5:10 AM

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Billybob, I didn't mean to touch a nerve.

However, the point I was attempting to make is, understanding

your limitations when investing is by far the most important point of

all the points Sam Lee is making, in my opinion. The other pointsare important but not nearly as much.

Whew, I have never had to explain the alternate use of the "noise"

term before but I will be much careful next time.

Billybob207

Jan 8 2014, 8:29 PM

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To Rockymoutains:

"Noise" = discussion that you don't agree with...or just don't like. So

many of us are just searching for commentary that makes us feel

"right". I am no different. But this article is spot on. Perhaps youhave put your money with some high priced guy or you actually

have beat the market over the last 10 or more years. If so, enjoy

Beginner Mistakes http://news.morningstar.com/articlenet/article.aspx?id 624997

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your exceptionalism. That is not the norm. To each his own. Peace.

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