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Review: The New Coffeehouse Investor

coffeehouseinvestorcoverCourtesy of a giveaway run by Laura of Green Panda Treehouse, I recently received a copy of Bill Schultheis’s The New Coffeehouse Investor.

The message of the book is that it’s possible to invest in such a way that you can meet your goals without having to pay attention to day-to-day market movements, product pitches from brokers, or meaningless noise coming from the financial media.

Given that that’s precisely the message of this very blog, it should be no surprise that I quite liked the book. 🙂

The Three Coffeehouse Investing Principles

Schultheis argues that the following common sense principles are all you really need to know in order to invest successfully:

  1. “Don’t put all your eggs in one basket.”–Diversify within asset classes and across asset classes.
  2. “There’s no such thing as a free lunch.”–Markets are (mostly) efficient. Use index funds rather than trying to beat the market.
  3. “Save for a rainy day.”–Make sure you’re saving enough to meet your goals.

I think he’s spot on with all three. (At the same time, I can’t help but be amused by the juxtaposition of principles #1 and #2, given that diversification has often been described as a “free lunch.”)

Money and Life

The book also offers sound financial advice outside of the realm of investing. For example, Schultheis is a big proponent of tracking your spending:

“I hate budgets as much as you do, but keeping track of expenses has nothing to do with budgeting and everything to do with creating an awareness of how I spend my money.”

That sums up exactly why Kalinda and I track our expenses as well. It’s not about setting restrictions. It’s about making sure that the way we use our money is actually in line with our goals and values.

Would I recommend it?

I think The New Coffeehouse Investor provides an excellent, easy-to-read introduction to buy & hold index investing. It is, however, not very heavy on facts and figures. If you’re into that type of thing, I’d suggest picking up The Four Pillars of Investing or The Little Book of Common Sense Investing instead.

And of course I won’t neglect to mention that if you buy The New Coffeehouse Investor together with Investing Made Simple, you’ll qualify for free shipping from Amazon. 🙂

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Comments

  1. >that diversification has often been described as a “free lunch.”

    I’m not sure if I agree with that… it’s still a trade off, you give up the possibility of superior (and inferior) return… it’s just likely a good choice for most people.

    Similarly, is switching from a higher cost closet index fund to a low cost index fund a free lunch, or just fixing a mistake?

    -Rick Francis

  2. Rick: As to diversification being a free lunch, you actually nailed the reason precisely. 🙂

    Because you give up both the potential for superior and inferior returns, there should be no net change in expected return–or, to put it differently, no cost. Yet your volatility (the typical stand-in for risk) goes down.

    At least, that’s how Markowitz’s argument goes, as I understand it.

  3. Rob Bennett says

    I can’t help but be amused by the juxtaposition of principles #1 and #2, given that diversification has often been described as a “free lunch.”)

    Precisely so!

    And please don’t think that diversification is the only case of a free lunch being discovered in this goofy old world of ours. How about indexing? Is that not a free lunch? You get huge diversification for virtually no cost. That sure sounds like a free lunch to me.

    The world is full of free lunches. Taking valuations into consideration is a huge free lunch, in my view. Why doesn’t everyone do it? Because some have taken the “there’s no free lunch!” injunction to such an extreme that they don’t believe that there will ever again be an advance in our understanding of how stock investing works since the insights that were mined in the 1960s. I don’t think that comes even close to being so.

    Should we be skeptical of free lunch claims? Yes. These claims can be empty and dangerous. But when skepticism becomes close-mindedness, we hurt ourselves. The investing ideas discussed at this blog are rooted in wonderful free lunch claims. And there will always be new free lunches to be discovered for so long as there are humans open to learning experiences. Learning is a free lunch! When you think about it, you realize that life itself is a free lunch! Did any of us pay the price of a ticker for this wild adventure ride?

    Rob

  4. kenyantykoon says

    seems to be a good read. i have recently decided to intensively increase my financial education and i am reading all the finance books that i can get my hands on. if i come across it i will surely read it

  5. I don’t like to call diversification a, “free lunch.” I’d rather call it a, “healthy lunch.” It still isn’t free, but at least you’re not paying extra (via taking other-than-market risk) to get the same market returns.

    Unrelated: Mike, OK, I’ll try it for a bit and see how it goes.

  6. Mike,

    Economists are a strange lot- the “no free lunch” argument isn’t just about actual costs. It is used to demonstrate opportunity cost, the utility you give up for any mutually exclusive choice. The free lunch- has the bill completely paid and there are no obligations for accepting it. Any normal person would say that is a free lunch, but an Economist wouldn’t as there is still an opportunity cost. You gave up doing something else to have that lunch. With that time you could have worked earning extra income. Even when the utility of your second best option is less than your actual choice the opportunity cost is still positive.

    There is even a real cost for buying index funds you have to forgo telling exciting tails of your stock exploits at parties :-).

    Rob,
    >you realize that life itself is a free lunch! Did any of us pay the price of a >ticker for this wild adventure ride?

    Maybe I did…I can’t really remember. It depends on what the alternative to living is… I’m no expert on the afterlife, but potentially life could have a really huge opportunity cost! 🙂

    -Rick Francis

  7. Rick: I’m familiar with the concept of opportunity cost. As I understand it, the point made by Harry Markowitz (the Nobel Prize-winning economist who first put forth the idea that diversification is a free lunch) is that there is no opportunity cost for diversification–or, more precisely, that there’s a negative opportunity cost (i.e., a forgone negative outcome) equal to the positive opportunity cost (the forgone positive outcome).

  8. Here is why I argue that diversification is not a “free lunch.”

    The “lunch” is market returns. The cost for diversification is market risk. That’s not free. Market returns without any risk sounds more like a free lunch to me.

    For the non-diversified, there are additional costs (company risks, sector risks, underperformance risk, etc) for the same market return “lunch.” Yes, some non-diversified portfolios will return above the market, but for that to happen, others must return below the market equally.

    There is no doubt that lunch costs more if you’re not diversified, but that doesn’t make diversification “free.”

    It can be argued that anything and everything has the potential for an opportunity cost, and I agree with Mike that diversification has a negative net opportunity cost.

  9. Ah. I think we’re actually in agreement here. It’s just a different comparison being made.

    When people say diversification is a free lunch, the comparison is between a diversified portfolio and an undiversified portfolio with the same expected return and same level of market risk. (End result: Diversified portfolio has same expected return yet less risk. A free lunch.)

    The comparison you’re making is between a diversified portfolio of risky assets and a (diversified? undiversified? does it matter?) portfolio of risk-free assets. (End result: Diversified portfolio has greater expected returns, but with greater risk. Not a free lunch.)

    Or to say it differently, I can’t imagine that people would argue that holding equities (or other risky assets) is a free lunch. Just that if you’re going to hold equities, diversifying your portfolio among equities is a free lunch.

  10. “When people say diversification is a free lunch, the comparison is between a diversified portfolio and an undiversified portfolio with the same expected return and same level of market risk.”

    That’s the comparison that I’m making as well. And I don’t disagree with the concept that diversification costs nothing extra. I just don’t like to call it “free.” “free” and “no extra cost” are not the same to me.

    If the lowest cost sandwich is $1, but that same sandwich can be bought for $2, $3, or $5. Buying the $1 sandwich is not a “free lunch.” Is just the best deal.

    I think calling stuff like this a “free lunch” just adds fuel to the “diversification (or asset allocation, or buy & hold) does not work” zealots’ fire when a portfolio has a negative returning year despite being diversified. I can already hear their sarcastic inquiries, “where’s your ‘free lunch’ now?”

    Rob, you have now idea what I am thinking. And I have absolutely no idea as to what in the world you’re thinking.

  11. “I just don’t like to call it “free.” “free” and “no extra cost” are not the same to me.”

    Ah. Fair enough. No arguments there.

  12. Rob, you have no clue as to what ideas I am and am not keen on, and I have no interest engaging you in any further discussion.

  13. Rob Bennett says

    Market returns without any risk sounds more like a free lunch to me.

    You certainly are not alone in thinking that investment returns come at the cost of taking on risk, Dylan. But this has never been proven in any scientific sense. It is a theory.

    I do not believe that investors are being compensated for taking on risk. I believe that we are being compensated for permitting our money to be used to build productive enterprises.

    There’s risk in that, to be sure. But the amount of risk that one must take on to earn X return is not fixed. There are all sorts of things that one can do to minimize one’s risk while not diminishing one’s returns. All of these things can be viewed as “free lunches” by those who think that only taking on more risk can generate a greater return. But, again, that’s a theory, not a proven reality.

    Diversification greatly reduces risk. If I allow one company to use my money, I am taking on a chance that that one company will go bankrupt. When I buy an index fund (much more diversified), that risk is greatly diminished. I limit my upside by doing this (individual companies have the potential of generating returns far in excess of those generated by an index). It is fair to say that there is a cost of diversifying. But I believe that there is a free lunch element to this choice as well. The mix of upside and downside is much better for the individual investor making the choice that provides greater diversification (index funds).

    I don’t believe that diversification is the only free lunch available to investors. I believe that there are lots of them. Every advance in our understanding of how investing works can be characterized as a free lunch. If we rule out free lunches, we are essentially ruling out ever learning anything new about how to invest effectively. I learn new things all the time. So I see little appeal in the idea of walking the “no free lunch” path.

    Rob

  14. Rob Bennett says

    I can’t imagine that people would argue that holding equities (or other risky assets) is a free lunch.

    Just for the record, I would say that.

    I put in $100 and at the end of the year I have (on average) $106.50. That’s a free lunch, in my eyes.

    It’s the product of economic growth. We don’t pay for economic growth. It’s just one magical aspect of this wonderful thing we call “Life.” This is why I often reduce my argument to the claim that “life itself is a free lunch.”

    If there were no free lunches, there would be no growth, there would be no average return of 6.5 percent real. That’s a sort of gift that life gives us. We should be grateful. It’s as much a free lunch as picking an apple off a tree is a free lunch. We should be grateful for both the apple and the average return of 6.5 percent real, in my view. If these things were not available to us, we would sure notice the difference.

    Rob

  15. Rob Bennett says

    Rob, you have no idea what I am thinking. And I have absolutely no idea as to what in the world you’re thinking.

    Perhaps, Dylan. It certainly is so that no two humans can ever understand each other perfectly.

    But my sense from reading between the lines of your response to Mike is that you get the general idea. Questioning of the “there is no free lunch” idea is questioning of a premise of the Passive Investing model. I am in favor of such questioning and you are not so keen on the idea. I think that’s the difference between us, Dylan.

    My belief is that we all are going to experience a giant leap forward in our understanding of how investing works when we get to the point where we are okay with questioning our starting-point premises.

    Rob

  16. Rob Bennett says

    I have no interest engaging you in any further discussion.

    I of course respect your call re that one, Dylan. The feeling is not mutual. I am grateful for your contributions and will continue to try to learn from reading them despite our different takes on a few issues. I am confident from reading your stuff here and elsewhere that there is much more re which we agree than there is re which we disagree. But I of course understand if you elect not to respond to my posts. And you of course have my best wishes in all your life endeavors regardless of your call on this one rather insignificant-in-the grand-scheme-of-things matter.

    Rob

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