Review: The Elements of Investing

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Every other Sunday, The Simple Dollar reviews a personal finance book.

elements of investingThe Elements of Investing by Burton G. Malkiel and Charles D. Ellis is a nice small volume, reminiscent in size and length to one of the Little Book investment volumes. I chose to pick this up because I highly respect Malkiel’s books A Random Walk Down Wall Street and The Random Walk Guide to Investing (click on the titles for my reviews) and I was looking for a succinct collection of the main points in those books (which are a little dense – and perhaps a little long – for the typical reader).

That’s pretty much exactly what The Elements of Investing delivers.

Malkiel and Ellis break down the … well, elements of investing down to five key principles, which make up the five main sections of the book. Given that this book isn’t excessively long, each of these sections gets straight to the point, making it clear what you need to do.

This book doesn’t offer (much) specific investment advice. Instead, what the book focuses on is the foundational elements you need to have in place in order to make good specific investment choices, along with a few very general principles on how to invest. If you’re looking for a list of hot stocks or other specific investment choices, this isn’t the place for you.

Let’s dig into the five key principles that make up the book.

I. Save
The book opens with what I consider to be the key of successful investing: saving your money, living without personal debt, and spending less than you earn. If you’re not following those principles, you’re giving money you could be potentially investing to financial institutions in the form of finance charges, unnecessary insurance, and so forth.

Before you begin to invest (outside of matched retirement savings and the like), get your personal finances in order. Eliminate all of your high-interest debt, as investing in such debt payments has a very high rate of return. Get into the practice of spending less in your personal life than you’re bringing in, because the less you spend, the more you have to invest. Live frugally. Build up a nice cash emergency fund to handle the curveballs life will throw at you so that such curveballs don’t disrupt your investing plans. Set goals for yourself and know why you’re investing.

II. Index
Malkiel and Ellis recommend investing your money in index funds rather than in individual investments (like individual stocks or individual commodities) or in mutual funds. First, investing in individual investments requires a substantial amount of research and access to information in order to compete – something not available to the average investor. Second, investing in mutual funds means paying substantial fees – and even after you do that, you’re still merely betting that, after you pay the fees, the fund manager can still beat the market, something no fund manager (other than arguably Peter Lynch, who retired about two decades ago) has ever done with any consistency.

Index funds simply buy a little sliver of everything and rides the market as a whole, doing it for an extremely low cost. You won’t beat the market – but you’ll match it without worry and extensive research. For the average investor who doesn’t have unlimited time and resources, that’s a pretty strong deal.

III. Diversify
Putting all of your eggs in one basket might get you rich, but it might also cause you to lose everything. For example, if you put everything into tech stocks in 1998, you were riding very high in 2000 – but in 2002, you were in an apocalyptic situation.

Instead of falling into this trap, diversify. Spread your money across a lot of different investments – domestic stocks, international stocks, bonds, cash, real estate, and even a bit of commodities, too. Buy index funds for all of these markets and spread your money across them. This way, you’re protected if any specific market collapses, but you also get some benefit if any particular market goes crazy.

IV. Avoid Blunders
Don’t get overconfident – no one can predict the future. Don’t try to time markets because, again, no one can predict the future. Be careful about fees and don’t invest in things that charge you a lot simply to invest in them.

To put it simply, be careful. Take your time. Your goal is to succeed in the long run – it’s not some sort of mad dash to the finish line. Besides, those who sprint often fall flat on their face when they’re in the investing game.

V. Keep it Simple
If things are getting too complicated and confusing and you’re finding that you’re having a hard time keeping track of your investments and properly following them, simplify. Move into fewer investments while still keeping as much diversity as possible. Instead of having your fingers in twenty different stock investments, invest in a much smaller number of index funds, for example.

Simplicity enables you to actually keep track of and understand your investments in a reasonable period of time. Without this, you’re essentially leaving your investments up to serendipity – which is never a good decision.

Is The Elements of Investing Worth Reading?
The Elements of Investing is an excellent first book for people to read once they begin to think about investing. Instead of drowning the reader in specific investment advice, it focuses on foundation materials. Why are you investing? How do you get ready to take advantage of the financial rewards of investing? How do you begin to invest if you barely know how to read a prospectus? How can you avoid some of the most obvious blunders that beginners have?

This isn’t a be-all end-all guide to investing, nor does it claim to be. If you want a deep, technically rich guide to investing, read The Bogleheads Guide to Investing. If you’re just starting to think about investing, read this one instead – it’s a truly great beginner’s book written by a author with a great reputation.

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3 thoughts on “Review: The Elements of Investing

  1. Thanks for reviewing this, it sounds like it would be a good beginner’s book as you state.

    I probably won’t get it, since I’ve heard pretty much all the book has to offer (based on your summarization).

    I wonder what the authors think of ETFs (Exchange Traded Funds), some have very low fees…

  2. I just finished this book and agree with the reviewer, it’s a pretty decent book for newbies, but doesn’t offer much to those who know a little about investing. I, however, wouldn’t recommend it to my friends new to investing because while newbies are the target audience, the writing style is much more geared to those who are more financially literate. I think most people unfamiliar with this kind of literature would respond better to a more entertaining primer (i.e. The Wealthy Barber, The Top Ten Distinctions between Millionaires and the Middle Class, Five Lessons a Millionaire taught me about life and wealth). Nice quick read for a review of good financial moves, but not the best book out there and certainly not up there with Strunk & White’s classic “The Elements of Style.”

    RE: MoneyReasons
    The authors like ETFs if they index and you’re buying them in large quantities.

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