The Elements of Investing book review

I get a kick out of this.  Try finding a book (any book) on finance that makes this claim:

Statistically speaking, the odds are that you can pick actively managed mutual funds and create a portfolio that will beat—after all fees and taxable expenses—a diversified basket of stock and bond index funds.  Or, if you can’t do it yourself, the odds are that you will find someone who can.

OK—you’d think you could find the above claim somewhere, right?  

But after reading more than 300 finance/investment books, I have never seen a book (or an academic study) state this claim.  In fact, the exact opposite is true–consistently.  … read more 

Yet advisors and salespeople try telling you that it’s easy to beat the results of a bunch of indexes.  They’ll come up with all kinds of excuses suggesting that you should invest with them.  But no studies can be found to support their claims. Shame on “advisors” for putting the odds of success against you!!

Burton Malkiel and Charles Ellis have teamed up to create a nifty little book, The Elements of Investing.    These Ivy League professors have been shouting out their message for years along with their peers, including a string of academic Nobel prize-winning laureates who suggest that the products sold by most financial planners are definitely not the way to go.

This book is great for a first-time finance reader.  There’s a bit of terminology in the foreword that might catch a few people off guard, but if you can get your head around a few of the sticky terms, it should be relatively easy reading.

There are some financially educated people who read this blog, and if you’re picking up this finance book with the hopes of understanding it, perhaps they can help.

If you have a question pertaining to anything in this little book, please put your question in the comment section provided.  I (or one of my other readers) will be glad to help.  And others, who see our questions and answers, will be able to learn from the thread.

I hope you get a chance to read the book–and learn from it.

Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School and Millionaire Expat: How To Build Wealth Living Overseas. My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I'm happy to comment on your questions.

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28 Responses

  1. Natalie says:

    Nice book and very simple. I am about 1/3 of the way through. I love the analogy of the 65year old and the time they invested. Very powerful. So far no questions.

  2. Andrew Hallam says:

    Hey Natalie,

    That was the story of the 65 year old who was given $1000 at birth, the parents invested it in the U.S. stock market, and now he has about a million dollars, right? It's true what Einstein said about the power of compound interest being more powerful than the splitting of the atom.

    If you have any questions, give me a shout. Others will be able to learn from your questions.



  3. Vicki says:


    Tell the story of how different a $10,000 investment would look if it were invested in index funds versus an activitly managed portfolio over the course of 30/40/50 years. Or, use the $1000 at birth example instead that is being referenced here. You wrote this "story" up in one of your investment semiar handouts a few years ago. I just re-read it when I was sorting through our filing cabinet this weekend (let me tell you how fun that was). The story speaks to not only the power of compounding, but also the "buyers beware" if one chooses to go the activitly managed route with fees, fees, and more fees.


  4. "Yet advisors and salespeople try telling you that it’s easy to beat the results of a bunch of indexes. They’ll come up with all kinds of excuses suggesting that you should invest with them."

    Of course they would; they have a vested interest in doing so, and fear & greed are easy emotions to manipulate.

    The real question is when the central banks will stop this monetary pumping that drives up asset prices and gives so many of these guys a job. It is this distortion of the economy that transfers so much wealth to them.

    Can you imagine if 1/3rd of our real resources (just a guess; I'm lumping in tax collectors along with these finance guys) were redirected toward more productive ends? A lot of these finance guys would be worse off, but the best ones would be kept; the ones that actually do contribute instead of just skimming off the indexes. Everyone else would be much better off as well…

  5. Totally agree! I read the magazine Money Sense and for a good number of years they have had their Couch Potato investment strategies based on ETFs and index funds and it's clear every year that it beats the market. Initially, they were proving out the theory but it has been clear the last few years their theory is paying off with very low fees and stress.

  6. Andrew Hallam says:


    I totally agree with you. And I think it really starts with education. If people understand how expensive actively managed mutual fund fees are (especially Canada's) and if they understood how detrimental those fees are, compared to alternatives, then the entire industry would have to become more competitive. I also agree with your statement about the "best" having the right to remain. It's funny though. Long term, the "best" tend to be the cheapest, as an aggregate.

    Passive Income Earner,

    I've become good friends with Ian McGugan, the founding editor of MoneySense magazine. And now that he has moved on from MoneySense, I figure I can tell you something he told me a few years back, with respect to the couch potato indexed portfolio that they backtested to 1976, and continue to track.

    The publishing company (Rogers publishing) would not let him post the results compared to the average Canadian actively managed mutual fund. The long term numbers make the average actively managed mutual fund look silly, but Rogers wouldn't let them publish those figures. If you think about where a magazine generates most of its revenue, you'll understand why (advertisements from financial service companies)

    When Ian started MoneySense nearly 11 years ago, his goal was to "tell the truth". But he had to balance along that fence of pleasing the owners.

    Thanks for the comment!


  7. Andrew Hallam says:

    Some of you can see Vicki's comment above. She had an advisor with H&R Block, and he suggested that he could beat a diversified basket of index funds with his carefully chosen actively managed funds. (And of course he would say that, right Kevin?)

    Anyway, we decided to put him to the test. Most advisors "claim" that they can do this, and they'll often point to funds that have done it in the past and say, "see I would have picked those for you five years ago, and you would have beaten the indexes" Sure–and you knew the winning lottery numbers ahead of time too, right?

    Vicki showed me her account with H&R Block, and we decided to track it using, compared to a portfolio of the U.S. stock market index, the international stock market index and the U.S. bond market index.

    Her advisor, "Dan" also took 1% annually as his "advisor's fee"

    It has been 2.5 years since we decided to make this comparison. Including the advisor's fee, Vicki's account with Dan would be 9.04% behind her Vanguard indexed account. After taxes, it would be even worse over time.

    So–back to the analysis Vicki wanted me to show. We can do it in theory and in practice.

    Vicki would have been on a pattern of losing about 3.5% compounding per year, as compared to the indexed alternative.

    If that were to continue (as it very likely would) these would be the differences if she chose to invest $1000 today for her baby in Vanguard indexes versus with Dan's actively managed funds—accounting for the 3.5% performance lag she would have had with her "professional advisor". Let's assume that she invests this $1000 for her baby, and her baby gets to receive it at age 65. (When little Kasey is no longer a baby!)

    $1000 invested at 6% per year for 65 years = $44,144,971

    $1000 invested at 9.5% per year for 65 years = $364,684.87

    Vicki's old advisor, about a year later, said "here's a fund that has beaten the indexes for the past five years or so; I recommend it."

    I suggested to Vicki that it likely wouldn't beat the index going forward. The odds were too slim. So we tracked it on using the U.S. total stock market index as a comparison. So far, the chosen fund is 2.14% behind in just over a year.

    If you're interested in long term statistics on actively managed funds compared to indexes, you can check out an old blog entry here:

    Thanks for the comment Vicki! By the way, readers: Vicki has dumped her advisor.


  8. Natalie says:

    So I have a few questions that needs clarifying and others might have the same.

    On pg 35 there is a chart that states "Percentage of Actively Managed Mutual Funds Outperformed by the S & P 500 Index.

    1 yr 61% 3yrs 64% 5yrs 62% etc…………..

    I do not understand what this chart is saying????????????

    Second question: pg 43

    Again another chart on index bonds

    It states % of Actively Managed Bond Funds Outperformed by Government and Corporate-Bond Index

    Gov't Corp

    Short-Term 98% 99%

    Inter Term 88% 73%

    Long Term 70% 57%

    What do these % mean??

    Pg 46 What is an ETF???

  9. Don't the active managers end up eating up 80% of your returns over time? Not to mention the fees they like to charge…

    Did I mention that I'm trying to transfer out of one of these idiots (long story… GF's acquaintance is an advisor and she bought a couple investments with her some years back), and they want us to charge 5.5% fees for doing so? At least we only have a couple of K with those guys!

  10. Andrew Hallam says:

    Thanks for the questions Natalie. If you're asking them, I'm surely going to have other readers who may be stumped by this as well.

    You asked:

    On pg 35 there is a chart that states “Percentage of Actively Managed Mutual Funds Outperformed by the S & P 500 Index.

    1 yr 61% 3yrs 64% 5yrs 62% etc…………..

    Natalie, these (above) are comparisons between actively managed mutual funds and the S&P 500 stock market index, before survivorship. It means that the S&P 500 index, over the past year, beat 61% of actively managed funds. Over 5 years, it beat 62% of actively managed funds etc.

    These references point to the superiority of indexes over actively managed mutual funds, but the results are heavily understated. Survivorship bias means that only the strongest mutual funds continue in existence, and the lousy funds disappear, merge with other funds, thus changing their names etc. These funds that "don't survive" don't go into the statistical comparison tables. If you did include them in the statistical tables, the results would look far worse for actively managed funds. Index funds would look even better.

    What's more, is that taxes aren't put into the above consideration either.

    David Swenson, Yale University's celebrated endowment fund manager suggests that after survivorship and taxes, more than 95% of actively managed funds (over a 15 year period) underperform the stock market index. In case you're curious, the S&P 500 index is a compilation of the 500 largest and most diverse stocks in the U.S.

    The same explanation holds true for the bond funds. Malkiel and Ellis could definitely strengthen their thesis further if they went into these other details, but perhaps they wanted to keep things simple for their readers.

    You also asked what an "ETF" is:

    This is an exchange traded fund–which is a type of index. If you're American, living in the U.S., there's little reason to worry about them because you have Vanguard, which sells fabulously cheap indexes, and even Fidelity, which sells even cheaper indexes as lost leaders. By lost leaders, I mean the following: Fidelity will attract people with their low priced index funds (which Fidelity actually loses money on) in the hopes that you might use their overpriced supermarket to buy some much more expensive actively managed funds.

    Anyway, if you're American, you can buy indexes far more easily than taking the ETF route. ETFs trade on stock exchanges. To buy them, you have to open a brokerage account, and you'd pay a brokerage fee to make the purchase.

    If you're Canadian, however, your availability of index funds via the banks (Vanguard style) really isn't available. Canadian banks sell regular index funds like Vanguard and Fidelity do, but the Canadian banks charge much higher fees to do so. Investing in Canada is generally pretty expensive. The expense ratios on their actively managed funds are double what they are in the U.S., and Canadian indexes charge about 4X what they would cost (in fees) via Vanguard or Fidelity.

    That leaves the ETF market the best playground for Canadian investors who want to buy cheap index funds. If you follow my blog posts on "Harry's Account" which you can see at the very top of my home page, you'll note that Harry's holdings are ETFs. He's Canadian, so he'd rather pay the small brokerage charge to buy an ETF than be fleeced by the high expense ratio rates of the Canadian banks' index funds.

    Natalie, I hope that helps. Let me know if you have any other questions.

  11. Andrew Hallam says:

    Hey Kevin,

    I'm sorry to hear about those back end loads. Readers, I'll explain what Kevin is referring to:

    There are three types of actively managed funds: no load, front end loaded funds and back end loaded funds.

    Years ago, an advisor sold Kevin a back end loaded fund. First of all, you have to realize that in the mutual fund world, you get what you don't pay for. In other words, studies show that "no load" funds outperform "loaded funds" even when we don't take the load expense into consideration. Advisors won't tell you that, because they (as nice as they might appear) want to get the most from you that they can. You might have a very nice advisor, but if they are selling you this garbage, well… they're not as nice as you might think.

    A front end load is a sales charge you pay every time you buy a fund. The American Funds fund family has class A funds (favorites with salespeople) that charge a 5.75% upfront fee. This means that if you invest $10,000 today, the salesperson gets to keep $575, so you only end up with $9,425 invested. You actually have to gain 6.1% the following year just to break even. It's a nice deal–for the salesperson.

    Potentially more lucrative for the salesperson is the back end load that Kevin is referring to. In most cases, if Kevin invested $10,000 in a fund, and he wanted to take the money back after one year, the salesperson would get to keep $700, or 7%. The longer Kevin owns the fund, the less of a percentage they can take from him when he withdraws. Generally, if you own the fund for 7 years, you can withdraw without a fee.

    The trouble is that if Kevin had kept adding money to that fund, only the money that he had fully invested for 7 years could be taken out without a penality. Anything he added within the past year (regardless of the fact that he owned the fund for 7 years) would incur a 7% penalty upon withdrawal.

    Kevin, please let me know how close to the mark I am here, with your particular fund (if you have the time)

    The noted finance writer, William Bernstein notes that, as an aggregate, no load funds perform better than loaded funds–even when we don't take the load into consideration. He says that you can ALWAYS find a better no low fund.

    In respect to loaded funds, he asks: "Are they illegal?" And then he answers his own question with, "No, but they should be!"

    When Kevin asks about actively managed funds costing the investor 80% over time, he's referring to the compounding effect that fees have over time.

    Even just a 1.5% difference has a huge compounding effect over time.

    Take $1000 over 50 years compounding at 7% annually and you get $29,457.02

    Take $1000 over 50 years compounding at 8.5% annually and you get $59,086.31

    The average Canadian equity fund has an expense ratio of 2.4% annually, compared to an indexed ETF charging about 0.17% annually. Now we're talking about a difference of 2.23%.

    This is where Kevin's statement about giving up 80% really gathers steam:

    $1000 invested at 7% for 50 years = $29,457.02

    $1000 invested at 9.23% annually for 50 years = $82,622.18

    Above, you're looking at the likely difference between investing in an average Canadian actively managed mutual fund versus an indexed exchange traded fund (ETF). The annual 2.23% advantage for the ETF is courtesy of the low fees. Again, check out my "Harry's Account" blog entries from the top of the homepage if you want to see some real-life running examples.

    Thanks Kevin. Your comments and additions are very welcome. In fact, I value them highly. Thank you!

  12. @Passive Income Earner – couldn't agree with you more: Couch Potato investing/index investing is proving to be more fruitful than mutual funds in the long-run; since the latter cannot beat the index. You're right; much less stress and investors keep more of their money in the process. Winning all around.

    @Natalie and others – if you're new to Andrew's site, check out "Harry's Account". Andrew has done a fine job in convincing fashion, proving ETFs and index investing is the way to go!

  13. Andrew Hallam says:

    Hey Financial Cents,

    Thanks! I also enjoy reading your blog. I find that I don't read too many finance blogs because it can take a lot of time. But I do check yours regularly–as you can probably tell!



  14. Thanks Andrew! I might have to buy this book, sounds like a good read. BTW – did you ever read "The Snowball"?

  15. Andrew Hallam says:

    Hey Financial Cents:

    Yeah, I did read Snowball. I thought it was fascinating. But you know, Alice Schroeder made some judgements about Buffett that I don't think he liked—re. his relationship with women, his mother, Catherine Graham etc. He was open with Schroeder, and cooperative when she was writing the book, but in the end, some of that hit a little too close to the bone. He has subtlely snubbed Schroeder and she's not really part of his inner circle anymore. I think she feels that. I just read her Bloomberg article about how the Berkshire Hathaway AGM is now like a circus. She's critical of him now in ways that she wasn't–thanks, I think, to the subtle cold shoulder Buffett has given her. It's funny how human we all are in the end.

    Did you read it? What did you think?

  16. Valentina says:

    I do invest in mutuals – have a monthly automatic amount that is earmarked for this, sort of my forced savings plan (and in Canada too). There have been times when I have raided this plan to move over to something that had bigger (if somewhat riskier) potential and must say that on the norm, the risk proved worth the taking.

  17. Hey Andrew,

    I agree, the Snowball was interesting from the perspective that it took a deeper look into Buffett as an outlier; hard time adjusting to grade school; an oddball when it came to meeting women; his life-long craving to feel accepted and valued. I think there's much, much more to him on that front that the public won't ever know, other than those in his inner circle, because any more details might taint the public's view of him. I think deep down, he's just as insecure now and as was 60 years ago as a teen. I'm not saying that's a tragic flaw, like you say, we're all human but we tend to put and keep the rich and famous on some esteemed, revered, exatled holy pedistal that can never be shaken. They are so dramatically different than the "rest of us". While I don't discount his genious per se as an investor, I do marvel at his success, it doesn't mean Buffett is perfect by any stretch and Alice tried to strike a balance between what she considered personal and professional success – for which I commend her. Although the Kitty Kelley book on Oprah is not a perfect parallel, I'm curious about that book for the same reason. Cheers!

  18. Latham says:

    Hi Andrew,

    Thanks so much for taking the time to help us all out. I'm a little over half way through the book, and the case made for index funds and bond funds makes a lot of sense.

    The question I have kind of deals with the bigger picture state of the financial world. A lot of the financial material I read talks a lot about how the worst of the financial crisis is yet to come. The thinking seems to be that the problems from derivitives and credit default swaps haven't really been dealt with, and the inevitable combustion of these things has only been put off and made worse by the governements' actions since the 2008 meltdown. Further they bring in the idea that we're living in extraordinary times as we are watching the process of the U.S. dollar losing its status as the world's reserve currency.

    I guess my main question is do you think that these conditions we're seeing today – where the U.S. could face a prolonged period of stagnant or even declining growth – change this game plan of investing in index funds and bond funds? I remember that you mentioned at your talk in the fall that in general when one goes up, the other goes down. Are there possible scenarios where both could fall together?

    Thanks again for your time. I'm looking forward to our meeting next week!


  19. Andrew Hallam says:

    Hey Latham:

    Where stock prices are 5, 10 or even 15 years from now won't matter for anyone as young as you.

    In fact, if you're very lucky, the financial crisis will get a lot worse, and hopefully, stock prices will be cut in half. With further luck, they'll stay down for a decade or more. As long as you still have a job, you'll really benefit from that.

    Bond prices will also drop in value if we have a serious crisis, but unfortunately, they won't drop nearly as far as stock prices.

    The only time bond prices dropped somewhat significantly was in 1929/1930, and U.S. government bonds started yielding 13.5% in 1931 and 15.3% in 1932. When the prices of bonds drop, the yields rise.

    Most people just dollar cost average into the stock market with an equal sum every month. Over the long term, they end up paying less than an average price–which gives them a nice long term benefit (it's better to buy low).

    The worst time to dollar cost average has always been during times of economic prosperity, when the markets have been rising in value. The foundations of wealth are always far more established when you can load up on stagnating assets like stocks or real estate, which never stagnate forever. At least, two world wars and a great depression weren't enough to keep them down.

    If you're in your early 30s or younger, looking at the current economic crisis (or the potential for one) is actually looking at the small picture. Looking at the big picture is thinking about where prices are going to be 30 years from now, when you're ready to start selling to live off your proceeds.

    For older people, if stocks and bonds both lose their value (such as with 1929/1930) a deflationary era will set in, as it did during the Depression.

  20. Natalie says:

    Thanks Andrew for the clarification. This is much clearer. It looks like I need to check out Harry's Acct.

  21. Andrew Hallam says:

    You're welcome Natalie,

    Harry's exchange traded index funds were purchased off the Toronto Stock Exchange, so they'll have different ticker symbols to what an American buying off the New York Stock Exchange would have. But still…the premise is the same.

    What's interesting about Harry's account, also, is that it reports in Canadian dollars. Because the Canadian dollar has gained about 14% on the U.S. dollar over the past year (and roughly that amount since Harry started his account in 2008) then the returns for Harry's account would actually be far higher if reported in U.S. dollars. For instance, a 3.5% Canadian dollar gain (under these circumstances) is equivalent to a 17.5% gain in U.S. dollars, since August, 2008. Considering that the world stock markets are currently lower now than they were in August, 2008, I see Harry's performance as spectacular. He benefitted from having a balanced account of stocks and bonds, and then responsibly rebalancing them when the markets plunged in 2009. The nice thing about having a balanced index (as with Vanguard) is that Vanguard will automatically rebalance it for you. Harry was driving a stick shift. For Americans, Vanguard lets you put the vehicle in cruise control.

  22. Hey Andrew,

    I really like your long-term perspective. Whenever I start feeling a little iffy because of all the bad vibes out there, it's important to remember that I'm doing this to reap the benefits in 25 years or so, not in the next 5! That's a good point about dollar-cost averaging, as well; if you have the funds and you're in a bull market then perhaps a lump sum is better; I've seen a couple studies recently that confirm this over the long run.

    Thanks for the detailed explanation about the loads and fees, as well. I haven't had the chance to confirm with my girlfriend and her advisor, but the situation seems to be almost exactly how you explained it. I am slowly convincing her to trust me as an advisor, instead… and in turn I look up to the wisdom of people who know what they're talking about, like you 🙂

  23. Latham says:

    @Andrew Hallam

    Thanks for helping to clarify that Andrew. I definitely see your point about the importance of looking at things in the 30 year time frame instead of the next few years. See you on Wednesday.

  24. kris says:

    Hey Andrew,

    Above you mentioned dollar cost averaging like visiting the supermarket every month. Am I buying milk, a necessity, or "treats" that I can wait for to go on sale? Is it worth having an unbalanced portfolio, stock or bond heavy, because the market is favorable to buy one or the other or is it prudent to simply maintain your asset allocation percentage regardless?

    Thanks for all the help fella.


  25. Andrew Hallam says:

    Hey Kris,

    History is full of peope who "overweight" in an area they think is going to do better than another. But the end game reality looks a bit like a scrapyard. Everybody thinks they can out-think the market and the public, but long term, if people keep trying, they end up disappointed. They might get lucky the first time, or the second time, but being right once becomes the kiss of death, as far as financial productivity is concerned—because those same people will want to try that stunt again. On the other hand, rebalancing mechanically makes you contrarian, by nature. In other words, when stocks are falling, you rebalance by buying stocks. When stocks are rising, you rebalance by buying bonds. This is going to be tough to do because every news article will be screaming the opposite. This is why Buffett suggests that investing is simple, but not easy.

    Thanks for the comment—cheers, Andrew

  26. Nathan says:

    I think I found my answer from the questions below. You don’t recommend ETF’s for Americans. I think I need to buy some international index funds, after I buy a few more bonds to get closer to 40% bonds, and I was thinking of ETF’s. Vanguard is advertising commission-free ETF’s, see below. Is it still better to not buy ETF’s for Americans? Are there any advantages to ETF's over regular index funds for Americans? Thanks Andrew!

    "Investing costs for Vanguard ETFs® and stocks just dropped substantially. Vanguard now offers:

    Commission-free Vanguard ETF® transactions. Vanguard brokerage clients can make commission-free transactions in our entire lineup of 46 low-cost ETFs—the largest suite of ETFs available without commissions.

    Ultralow equity commissions. Most Vanguard brokerage clients will pay $2 or $7 to trade stocks and non-Vanguard ETFs. (Some clients will receive 25 commission-free trades; others will pay $20 after 25 transactions, as shown in the accompanying table.)"

  27. kris says:

    Thanks Adrew,

    No problem for that idea here. If you are telling me the fast easy way is better I think I'l find a way to cope! I've got better things to do!

  28. Andrew Hallam says:

    Ahh, Vanguard just keeps getting better and better. Thanks Nathan. That's super news.

    I didn't recommend that Americans not buy ETFs. Vanguard indexes are just a lot easier to buy, and they have been commission free forever.

    With ETFs, the fees are even lower, so if you want to drive a stick shift, go for it. If you want an easy option, you can buy a Vanguard target retirement index fund, which will increase its bond allocation as you get older—thereby increasing your safety. If anything happens to you, it will be easier for Stacie to understand the target retirement fund as well. Just a thought, in case you ever feel like getting into one.

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