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Book Review: The Smartest Investment Book You’ll Ever Read by Dan Solin Thumbnail

Book Review: The Smartest Investment Book You’ll Ever Read by Dan Solin

This book does a good job of introducing basic investment concepts, and then moves on to explaining many of the pitfalls of investors.  Investors try to pick funds that will outperform based on historical outperformance, but studies show there is no predictive power from one five-year period to the next.  The most respected mutual fund rating system in the world, the Morningstar Star System does not show statistically significant performance edge for five star rated funds over four and even three-star funds.  Even Morningstar cautions that its system is not a predictor of future results. (p.62)   Solin calls out “hyperactive brokers” who move clients from one fund to another based on what is hot or Morningstar ratings.  Often, they get a new commission each time they make a switch.   He also calls them out for using funds that have special deals with their own firms instead of less expensive funds.  Instead, “smart investors” should refuse to work with advisors who receive compensation from anyone other than clients, as this creates a conflict of interest.  Another mistake is trying to time the market.  A study of 237 market-timing newsletters from 1980 to 1992 found that 94.5% went out of business, with an average life of just four years (p.56).  Another mistake investors make is taking on too much risk.  Studies have found that asset allocation is far and away the biggest determinant of returns.  It is also the biggest determinant of risk.  A diversified portfolio that has multiple asset classes (e.g. stocks, bonds, commodities) should have less risk than a portfolio loaded up on one asset class.   Bonds tend to be much lower risk than stocks.  A person’s portfolio should match their life situation – age, time horizon, cash flow needs and temperament.  Yet many investors have far too much devoted to stocks, leaving them vulnerable to large market swings.  Solin presents average returns and maximum one-year loss for various portfolio mixes.   This is helpful context, and fundamental to an investment plan, but he assumes that historical numbers will repeat themselves, and this isn’t necessarily the case.  In fact, since the publishing of the book, the safe portfolio would have lost mid-teens percent in 2022, much worse than the 1.69% max one-year loss in the forty-year lookback period of 1970-2004.  While the point that people with lower risk-tolerance should have more bonds in their portfolio is correct, the assumption that the incredible multi-decade run where that portfolio never lost much value portends future stability is incorrect.  Investors must be prepared for losses even in their bond portfolio.  Solin asks, “Are you comfortable with historical annual returns of 9.22%?  If so, why would you want to assume more risk?”  This implies a return of over 9% on a mostly bond portfolio is what investors should expect, but at today’s interest rates, this is virtually impossible.

Contnue reading the book review:

Book Review Smartest Investment Book.pdf