Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition

Part I. ON INVESTMENT STRATEGY

Investment strategy is the first issue that investors should consider. At the outset, investing is an act of faith, a willingness to postpone present consumption and save for the future. Investing for the long term is central to the achievement of optimal returns by investors. Unfortunately, the principle of investing for the long term—eschewing funds with high-turnover portfolios and holding shares in soundly managed funds as investments for a lifetime—is honored more in the breach than in the observance by most mutual fund managers and shareholders.

To bring the advantages of long-term investing into focus, I examine here the historical returns, and risks, that have characterized the U.S. stock and bond markets, as well as the sources of those returns: (1) fundamentals represented by earnings and dividends, and (2) speculation, represented by wide swings in the market's valuation of these fundamentals. The first factor tends to be reliable and sustainable over the long pull; the second is both episodic and spasmodic. These lessons of history are central to the understanding of investing.

This discussion of returns and risks serves as a background for a discussion of asset allocation, now conceded by virtually all thoughtful observers to be by far the most important single decision in shaping the long-term returns earned by investors. Finally, I deal with the paradox that, more than ever in these days of complexity, simplicity underlies the best investment ...