The Little Book of Common Sense Investing, Updated and Revised

Chapter OneA Parable

The Gotrocks Family

EVEN BEFORE YOU THINK about “index funds”—in their most basic form, mutual funds that simply buy shares of substantially all of the stocks in the U.S. stock market and hold them forever—you must understand how the stock market actually works. Perhaps this folksy parable—my version of a story told by Warren Buffett, chairman of Berkshire Hathaway, Inc., in the firm’s 2005 Annual Report—will clarify the foolishness and counterproductivity of our vast and complex financial market system.

Once upon a Time . . .

A wealthy family named the Gotrocks, grown over the generations to include thousands of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all of the earnings growth that those thousands of corporations generated and all of the dividends that they distributed.¹ Each family member grew wealthier at the same pace, and all was harmonious. Their investment compounded over the decades, creating enormous wealth. The Gotrocks family was playing a winner’s game.

But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than their relatives. These Helpers convince the cousins to sell their shares in some of the companies to other family members, and to buy shares of other companies from them in return. The Helpers handle the transactions and, as brokers, ...