The academic and professional literature on investing isn’t always easy to make it through, but for a committed student of investing, the endeavor is valuable. Below we’ve begun a library on topics of interest, with some pieces from the popular press mixed in too. If you find that something great is missing, please add your suggestions in the comment box. Also, please weigh in on any you found particularly useful, or not.

Diversification | Rebalancing | Expenses | Active and Passive Investing | Taxes | Behavioral Finance | Books


A Random Walk with Burton Malkiel
Registered Rep, 2003

Diversify, not only across stocks, but across asset classes. How you allocate across asset classes should be determined by your age and risk tolerance.

Beginner’s Guide to Asset Allocation, Diversification, and Rebalancing

Securities and Exchange Commission

Explains the benefits of diversifying among stocks, bonds, and cash, based on your risk tolerance and time horizon. Also promotes rebalancing as a way to reduce risk.

What’s in Your 403(B)? Academic Retirement Plans and the Costs of Underdiversification
John Angus, William O. Brown, Jr., Janet Kiholm Smith, Richard L. Smith, 2006

Finds that diversifying your investments can have a huge impact. One somewhat sophisticated approach lead to a doubling of wealth at the end of a 40 year work life. And even a “naive diversification strategy” of putting an equal amount into every available fund, outperformed their restricted portfolio by 33%.

Lost- and Found
Craig L. Israelsen, 2010

Given the proper asset allocation, the Lost Decade was not as bad as it could have been.

Global Diversification
Meir Statman and Jonathan Scheid, 2004

Global diversification is still beneficial, even though the correlation between US stocks and international stocks is higher than before. Correlation is a misleading metric for measuring the benefit of global diversification because standard deviation is important, too. Even though correlation might seem high, it does not eradicate the benefits of diversification.

International Diversification at Home and Abroad
Francis Warnock and Fang Cai, 2004

Investors can get significant exposure to global markets by investing in domestic multinationals. After accounting for home-grown foreign exposure, the share of ‘foreign’ equities in investors’ portfolios nearly doubles, reducing (but not eliminating) the observed home bias.

The Benefits of International Portfolio Diversification
Jose Luiz Barros Fernandes and Jose Renato Haas Ornelas, 2010

This paper evaluates whether the inclusion of new asset classes add value to a traditional conservative portfolio of USD and EUR bonds. The benefits of diversification for a conservative investor were questioned during the financial crisis. The authors find diversification benefits are higher for less risk averse investors, and that depending on risk preferences, diversification may not be worth it, as the benefits do not outweigh the increased monitoring and transaction costs.

An Introduction to Investment Theory
William N. Goetzmann

Outlines the basics of Modern Portfolio Theory – mean return, standard deviation, and correlation. Argues diversification among uncorrelated assets can increase returns, decrease volatility. As long as correlation is not 1 or -1, diversification can be beneficial.

The Legacy of Modern Portfolio Theory
Frank Fabozzi, Francis Gupta, and Harry Markowitz, 2002

Reviews Modern Portfolio Theory, 50 years after its introduction, and finds the theory still largely applicable and useful. Reviews the difficulties of applying the idea of diversifying with uncorrelated assets to reduce risk while increasing return, such as the usefulness of past data in predicting future returns and variances.

How much diversification is enough?
Meir Statman, 2002

Statman revisits the question he first sought to answer in 1987, and finds optimal diversification may require four times his original estimate. Arguing that the optimal level of diversification is the number of stocks at which the marginal cost of purchasing another stock outweighs the benefit it provides, and figuring in correlations, transaction and holding costs, and equity premium, he estimates the optimal number of stocks is 120. Most investors hold far less than 120 stocks, the average is 4. This may be, he supposes, because people think only of the upside potential of stocks, and are choosing a small chance at spectacular returns, rather than guaranteed mediocre returns.

How Many Stocks Make a Diversified Portfolio?
Meir Statman, 1987

A well-diversified portfolio should have at least 30 stocks. Most fall far short of this.

Reflections on the Efficient Market Hypothesis: 30 Years Later
Burton Malkiel, 2005

Active equity management is a loser’s game. The market may not be perfect, but for most investors low-cost indexing is the best approach.


The Art of Rebalancing
The Consulting Group of Smith Barney

Rebalancing usually decreases risk, and in some cases can increase returns. Higher-risk assets tend to have higher returns, so over time, they will occupy a larger portion of a portfolio, exposing investors to more risk than they want. There’s no single best method of rebalancing, but generally, it’s best to rebalance when volatility is high, return differences are narrow, and correlation is low.

Best Practices for Portfolio Investing
Vanguard Research (Colleen M. Jaconetti, Francis M. Kinniry Jr.,Yan Zilbering), 2010

To recapture your portfolio’s original risk-and-return characteristics, it should be rebalanced. For most broadly diversified stock and bond fund portfolios annual or semiannual monitoring, with rebalancing when any one category varies from the goal by 5% or more, should balances risk control and cost minimization pretty well.

Portfolio Rebalancing in Theory and Practice
Vanguard Investment Counseling and Research (Yesim Tokat), 2006

Rebalance to keep risk and return characteristics constant. Recommends rebalancing once portfolio allocation deviates 5% or more from the target allocation.

Optimal Portfolio Rebalancing in the Presence of Transaction Costs
Hayne Leland, 1996

Investors should set an optimal asset allocation, based on their risk tolerance. For example, a 60/40 stock-to-bond ratio. Set a band around the target allocation, based on the risk-free rate, expected returns of stocks and bonds, cost per unit of tracking error, and transaction costs. Rebalance when your asset mix strays outside of the band. Rebalance to the nearest boundary of the band, NOT to your target allocation. An optimal strategy can reduce transaction costs by up to 50%.

How to Rebalance Your Porfolio
Money Magazine’s Walter Updegrave, 2010.

A practical guide to how to rebalance your holdings and what’s most important to consider when doing so.


How Expense Ratios and Star Ratings Predict Success
Russel Kinnel, Morningstar, 2010

Low expenses are the single best indicator of mutual fund out-performance, better than Morningstar’s five star system.

On Mutual Funds, Cheaper is Better

John C. Bogle, 2010

In this Wall Street Journal opinion piece, Vanguard founder John Bogle, argues that mutual fund fees need to come down and to be far more transparent. The expense ratio of the average equity fund weighted by fund assets has risen to 0.86% in 2009 from 0.54% in 1960, he writes, an increase of 59%. During those fifty years, “equity fund assets have burgeoned to $5 trillion from $10 billion, a 500-fold increase. But fund costs rose at a far faster rate—to more than $42 billion from $50 million, a near 800-fold leap.” The benefits of economies of scale have not come to investors. Indeed, the total fees paid by equity fund investors rose to $42.7 billion from $2.3 in that time. Bogle is particularly perturbed at how much dividend income funds are consuming: 38.5% in 2009, versus 19.5% in 1990. Dividends are one of the major reasons stocks perform so well over the long term, so for investors that’s a big loss.

Measuring the True Cost of Active Management by Mutual Funds
Ross M. Miller, 2005

Mutual fund fees are far more expensive than commonly believed. Author tries to find the true cost of active management since funds engage in “shadow” or “closet” indexing, where investors are charged active management fees while the fund is simply an indexed fund. Explains the development of a method for uncovering the “true” costs and benefits of active fund management.

The Hidden Costs of Mutual Funds
The Wall Street Journal’s Anna Prior, 2010

Morningstar calculates the expense ratio of the average U.S. equities mutual fund at 1.31% of assets, but generally undisclosed trading and transaction costs take another 1% to 3% of fund assets. These costs — brokerage commissions, bid-ask spread, opportunity cost, and market-impact cost — must be overcome before fund managers can start to rack up positive performance numbers.

Bridging the Gap Between Employers’ and Workers’ Understanding of 401(k) Fees
Transamerica Center for Retirement Studies, 2010

75% of large company employees and 72% of small company employees either think their retirement savings is not affected by fees or are not sure if fees are charged. There are.

How Mutual Funds Can Cause Big Tax Payments in Bear Markets
Joshua Kennon

Some mutual funds hold stocks for many years before selling. If they made a net gain, this triggers capital gains taxes, which are passed on to investors, even if those investors were not invested in the fund for most of the holding period. So if someone invests a week before a stock that has been held for 15 years is sold, he must pay taxes on all 15 years of gains.

Mutual Fund Mortality, 12b-1 Fees, and the Net Expense Ratio
William Dukes, Philip English II, and Sean Davis, 2006

Even after adjusting for economies of scale, funds with 12b-1 fees have higher expense ratios net of the 12b-1 fees than funds without them. 12b-1 fees are highest for funds that ultimately fail. Overall expense ratios have increased over time. This is because as funds with traditional fee structures fail, they are replaced by start-up funds that typically use 12b-1 fees. The overall use of the 12b-1 fees has increased.

Active and Passive Investing

Luck versus Skill in Mutual Fund Performance
Eugene F. Fama, Kenneth R. French, 2009

There are so few actively managed funds that outperform, it’s not possible to differentiate skill from luck. An investor might pick the right fund, but the odds are so low that they’re right, it’s not prudent to take that risk.

The Arithmetic of Active Management
William Sharpe

Simple proof by Professor William Sharpe that the average passively managed dollar has a greater return than the average actively managed dollar. It does allow that a minority of active managers can beat the market.

The Difficulty of Selecting Superior Mutual Fund Performance
Thomas P. McGuigan, 2006

Attempts to quantify the relative performance of actively managed large and midcap domestic stock mutual fund’s with a passive strategy during a 20 year period. Finds most actively managed mutual funds underperformed their respective passive strategies, and the few who outperformed hardly managed to do so consistently. Predicting which funds would outperform was difficult, if not impossible, and the danger of selecting the “wrong” manager was high.

Security Concentration and Active Fund Management: Do Focused Funds Offer Superior Performance?
Travis Sapp, Xuemin Sterling Yan, 2009

After deducting expenses, focused funds significantly under perform diversified funds. Controlling for various fund characteristics, funds with a greater number of holdings perform better. Results indicate that managers holding focused portfolios do not have any superior stock picking skills, and the funds do not provide value to investors.

Why Indexation Can Be a Dangerous Strategy
Harry M. Kat, 2003

Stocks are placed in an index because of market capitalization, not because of risk-return analysis. Actual composition of the index changes continuously – stocks move in and out, and weightings change. For example, the technology sector took up more and more of the S&P 500 during the tech bubble. Thus, the risk-return characteristics of an index change constantly. This might be more volatility than an investor wants. Past risk/returns of an index may not be relevant anymore.

Survivor Bias and Improper Measurement: How the Mutual Fund Industry Inflates Actively Managed Fund Performance
Amy L. Barrett, Brent R. Brodeski, March 2006

Funds with the worst performance disappear, falsely making actively managed mutual funds look competitive with indexes. Active managers fail to add value when:measured versus appropriate benchmark, controlled for survivor bias, measured over a long period (10 years) encompassing an entire market cycle. Investors should have a strong preference for low cost passive investment strategies.

Agency Problems in Target-Date Funds
Vallapuzha Sandhya, March 2010
Study finds Target-Date Funds, the default option in many 401(k) plans, often under-perform balanced funds and blames the fact that Target-Date Funds are often structured as “funds of funds” and include poorly-performing and expensive base funds from the same fund family.

6 high-priced stocks worth the cost

Kiplingers, 2010

High-priced stocks can be worth the investment, despite the cost. The article gives six example companies, which the authors see as good investments despite trading over $100 per share.

The Date Debate: Should Target Date Funds Be Managed To or Through Retirement?
Russell Research, April 2010

Discusses Russell’s perspective on the ‘to’ vs. ‘through’ debate in the target date fund industry.


Loss Harvesting: What’s It Worth To The Taxable Investor?
Robert Arnott, Andrew Berkin, Jia Ye, 2001

By rigorously realizing losses, the median portfolio would add about 27% compared to a pure buy and hold strategy. Even after liquidation, net of all deferred taxes, the advantage is still 14%. In every case tested, loss harvesting added significant value.

Are individual investors tax savvy? Evidence from retail and discount brokerage accounts
Brad Barber, Terrance Odean, 2002

Study uses brokerage account data to analyze tax awareness of individual investors, and finds strong evidence that taxes matter: investors prefer to locate mutual funds and bonds in retirement accounts, and in December, harvest stock losses in their taxable accounts. However, investors also trade actively in their taxable accounts, realize gains more frequently than losses, and locate a material portion of their bonds in taxable accounts. So investors could improve their after tax performance by fully capitalizing on tax avoidance strategies.

Behavioral Finance

The Behavior of Mutual Fund Investors
Brad Barber, Terrance Odean, and Lu Zheng, 2000

Investors buy funds with strong past performance. Investors sell funds with strong past performance and are reluctant to sell their losing fund investments. Investors are sensitive to the way fund expenses are charged. They are less likely to buy funds with high transaction fees – however, their purchases are relatively insensitive to a fund’s operating expense ratio. Even though buying past winners can be reasonably justified, selling winners rather than losers misses out on loss harvesting. Mutual funds with high operating expenses have lower net returns than funds with low operating expenses. Investors should buy funds with low operating expenses and sell their losing investments.

Market Timing

Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability

Geoffrey C. Friesen, University of Nebraska at Lincoln – Department of Finance
Travis Sapp, Iowa State University – Department of Finance

Journal of Banking and Finance, Vol. 31, pp. 2796-2816, 2007

Over 1991-2004 equity fund investor timing decisions reduce fund investor average returns by 1.56% annually. Underperformance due to poor timing is greater in load funds and funds with relatively large risk-adjusted returns.

Bad Timing Eats Away At Investor Returns

Russell Kinnell, Morningstar

This analysis looks at the average performance loss due to bad timing by mutual fund investors for the decade from 2000-2009.

“Investor returns tell you how the average investor in a fund fared. We take monthly cash inflows and outflows and then calculate the returns earned on those flows. As with an internal rate of return calculation, investor return is the constant monthly rate of return that makes the beginning assets equal to the ending assets with all monthly cash flows accounted for. The gap between investor returns and total returns shows you how well investors timed their purchases and sales.”

“The grand total for the average investor in all funds in the aughts was a 1.68% annualized return, compared with 3.18% for the average fund. “

What these results show is is that over the decade from 2000-2009, bad timing decisions by mutual fund investors cost them an average of 1.5% per year.


Jim Otar’s Unveiling the Retirement Myth
Reviewer Steve Thorpe finds this a compelling argument for low rates of withdrawal from your retirement savings and factoring in the possibility of a lot of bad luck.

Meir Statman’s What Investors Really Want
Interview with the author.
The Many Errors Investors Make and a Few Fixes

Rick Ferri’s The Power of Passive Investing
Rick Ferri on Passive Investing, ETFs, 401(k)s and More

Larry Swedroe’s Wise Investing Made Simpler
Your Fund Manager is No Albert Pujols, and Other Lessons

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