Larry Swedroe has established a reputation as one of the clearest thinkers and best writers in the field of passive investing. Swedroe is the author of many books, including Wise Investing Made Simple: Tales To Enrich Your Fortune, which hit the bookstands last Monday.
“Larry has written some of the most sensibly and clearly written books anywhere for sophisticated passive investors,” said Jim Wiandt, publisher of IndexUniverse.com and the Journal of Indexes. “Now he has one-upped himself by writing the book we’ve always wanted to give to our friends, relatives and clients when they ask us for tips. With a fireside chat manner, Larry goes through a wide array of complex financial ideas by explaining them clearly through stories. I found the book to be thoroughly entertaining. And investing novices will find it to be invaluable.”
Swedroe spoke recently with IndexUniverse.com editor Matt Hougan about the new book and, more broadly, about his overall investing philosophy.
IndexUniverse.com: Tell us a little bit about the new book, and why you wrote it.
Larry Swedroe (Swedroe): The book tries to take a topic that a lot of people are scared of—money and investing—and bring it into the real world and make it simple and easy to understand by using stories … stories about sports, about family, about the things that aren’t scary. Because the basic concepts are easy to understand, and if you can get people to understand just a few key concepts, they’re going to be much better off in the long run. Most people remember stories more readily than a complicated chart.
IndexUniverse.com: Give me an example.
Swedroe: Well, I’ve found that the best way to teach people about investing is to tie it to the idea of betting on sports. Many people understand betting on sports, and not enough people understand investing. So one of the stories I use in the book is this …
Even someone who doesn’t know much about college football would recognize the answer to this question: If the University of Texas, a national contender for the championship every year, played a school called San Angelo State, which team is likely to win?
Easy, right? If they play 100 times, Texas would almost certainly win 100 of those games.
The problem is, if you’re trying to make money betting on Texas, you can’t do it. To make money, you might have to give the other team a 40-point spread.
As it turns out, the point spread is an unbiased estimator of the outcome. Even though a bunch of amateurs set the point spread by their betting actions, the favorites tend to win by more than the point spread half the time, and less than the point spread half the time. So it’s very difficult to make money betting on sports; the only people likely to make money are the bookies.
How does that tie to investing? Well, ask yourself the question: If you consider two companies, GE and Ford, you know that GE is the better company. But should you invest in GE just because it’s a better company? No, you have to pay a much higher price for GE than you do for Ford … the price-to-earnings ratio makes both of them equally good investments once you adjust for risk, the same way the point spread gives you an equal chance to win. In other words, GE is Texas and Ford is San Angelo State. Just as the point spread equalizes the risks of betting on either team, the difference in the P/E ratio makes both companies equal investments once we adjust for risk.
Most stockbrokers are nothing more than bookies. They just need you to play—to buy and sell stocks—and they pocket the commission. They win. You don’t win by playing their game. That’s why the bookies own the yachts, when it should be the investors that own the yachts.
I use stories like that one throughout my book to break down the myths about investing, to make it clear. Because stories are the easiest way to get people to learn.
If you tell somebody a fact, they’ll learn. If you tell them a truth, they’ll believe. If you tell them a story, it will live in their hearts forever.
IndexUniverse.com: Do you think younger investors with a longer time horizon should hold more small-caps, more international and more value exposure than the broad market? That seems to be the thinking among a lot of the DFA-inspired crowd.
Swedroe: Let’s begin by addressing this question: Why should anybody at all deviate from a market-cap-weighted strategy?
The answer begins by understanding that there isn’t one factor that determines equity returns. That’s what people used to believe—the more exposure to beta you had, the higher your expected returns and risk. But along came Eugene Fama and Kenneth French. They demonstrated that a three-factor model explains returns much better than the one-factor model. Beta explains about two-thirds of returns while the three-factor model explains about 95% of returns. And unfortunately, prior beta does not determine future beta.