Every now and then, some generous soul sends me a copy of a newly published book -- hoping, no doubt, that I'll have some kind words to say about it. Their wishes are often not fulfilled, either because I didn't manage to check the book out, or because I didn't like it all that much, or perhaps simply because I haven't had a chance to write it up.
I did recently receive a book, though, that I'd like to share with you. I haven't read it all, and don't know when I'll finish it, but I liked a lot of what I saw in it, and some good brains have praised it, too -- such as MIT's Nobel Laureate in Economics, Paul A. Samuelson; Princeton's Burton G. Malkiel; and John Bogle, founder of The Vanguard Group, and father of index funds.
Mark Hebner's Index Funds: The 12-Step Program for Active Investors is the book in question. It made a big impression simply upon arrival, as I had to round up a few friends to help me lug it inside my home. It looks like a cross between the Detroit phone book and an Abrams art history book. In other words, it's substantial -- and attractive -- stuffed with full-color graphs and charts and other illustrations.
The message matters
What matters most, though, is the book's message. It's hard for me to disagree with it, because it basically echoes what we at The Motley Fool have been saying for eons: Index funds are a terrific way for many, if not most, people to invest. Permit me to quote Mr. Hebner a little:
"The financial services industry has a dark secret, one that costs global investors about $2.5 trillion per year. ... The dark secret is that managers don't beat markets. The fact is that markets outperform managers by a substantial margin over long periods of time. This book offers overwhelming proof of this."
"My own journey to this unsettling truth began in 1985. It was then that I received about $6 million for the sale of a company I had co-founded. I immediately turned my newfound fortune over to a major brokerage firm with a stellar reputation and a fancy office in a towering skyscraper. How could I go wrong?"
"Like many investors, I didn't take the time to learn how the stock market works. ... It wasn't until 12 years later that I finally decided to figure out how my investments had performed compared to appropriate benchmarks. As I spent months combing through bookstores and surfing the Internet for information, the knot that formed in my stomach grew tighter. ... It turned out that my lack of understanding of how markets worked had cost me a mind-boggling amount of money. When comparing a risk-appropriate portfolio of index funds with what I actually achieved in my own portfolio over the last 20 years, I have ended up with $30 million less. I repeat, my portfolio earned $30 million less than a simple index fund portfolio."
12 steps
Hebner explains that many investors need to break "destructive patterns" of investing -- he's talking here about our common urges to gamble with our investment money, to trade more frequently than we should, etc. He organized his book as a series of 12 steps (or concepts) for investors to digest and sometimes act on. Here's one:
Step 4: Understand that no one can pick the right time to be in or out of the market. "When 32 market-timing newsletters were compared to the S&P 500 Index over a 10-year period, not one of them beat the broad market index. The primary reason ... is the high concentration of returns and losses that occur in a time period of a few days. In a 10-year period, about 88% the total gain was highly concentrated in just 40 days. It is impossible to pick those 40 days in advance."
Hebner devotes much of his book to discussing risk, including how to measure it and how to factor it into your ideal portfolio. In Step 9, he studies some historical data, pointing out, for example, that between 1945 and 1992, the S&P 500 "outperformed real estate by more than 50%, although the S&P 500 had about three times the risk."
One of his charts, based on data from Morgan Stanley, shows gold and silver yielding returns similar to those of Treasury bills (in the 4% to 5% range), but carrying much, much more risk. He rightfully points out that we investors often give short shrift to considerations of risk, which is not smart.
Hebner ends up offering suggested ideal portfolios for 20 different kinds of investors with varying risk capacities. He mixes large-cap indexes with those of small-cap companies, real estate, emerging markets, international companies, and bonds. Some of the funds he recommends include the IFA Real Estate Index, which invests in firms such as Simon Property (NYSE:SPG), Equity Office (NYSE:EOP), and Prologis (NYSE:PLD); and the DFA U.S. Large Cap Value Portfolio, which features stocks such as MetLife (NYSE:MET), JPMorgan Chase (NYSE:JPM), and Comcast (NASDAQ:CMCSA).
Aim for better than average
What Hebner's research tells me, based on what I've gleaned from the book so far, is that it's important to study any mutual fund you invest in carefully. He points out, for example, that some 40% of managers "drift" away from their original investing style into other styles.
I agree about the power of index funds, but I also think that we investors can outperform them by carefully picking individual stocks and managed mutual funds. You might even put the bulk of your investments in index funds and then enhance that performance with some additions. I invite you to consider taking a free trial of our Champion Funds newsletter service, which delivers outstanding mutual fund recommendations regularly. Last time I checked, the newsletter's total average return was 24%, versus 11% for its benchmarks. Lead analyst Shannon Zimmerman maintains three model portfolios, where he lists appropriate funds for conservative, moderate, and aggressive investors. Impressively, only one of his picks has lost ground, and that's down less than 2%. Six have risen by more than 49% or more, which is darn impressive for mutual funds.
You can learn a lot more about mutual funds and index funds in our Mutual Fund Center.
This article was originally published on Dec. 21, 2005. It has been updated.
JPMorgan Chase is a Motley Fool Income Investor selection.
Selena Maranjian 's favorite discussion boards include Book Club, The Eclectic Library and Card & Board Games. She owns shares of Comcast. For more about Selena, view her bio and her profile. You might also be interested in these books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . The Motley Fool is Fools writing for Fools.
