What about the content? Is it any good for the $4.97 I paid, or, (if you are not lucky to get the bargain) the $19.95 jacket price? According to the author Daniel Solin, this is the smartest book you’ll ever read because “it is simple. It is understandable”. And simple is good.

Between Chapter 1 and 35, the author talks about the follies of active (or what he calls “hyperactive”) investing as opposed to passive investing, where you buy and hold a diversified mix of index funds that track the entire financial market. There are interesting nuggets of facts and wisdom here and there. For example, between 1985 and 2004, the average annual return of all actively managed funds was a mere 3.7%, whereas the S&P 500 Index returned a whopping 13.2%.

None of this is new to an experienced investor, who is already well versed in the differences between index investing and stock picking. But this is where the story-telling skill of the author becomes important, because no matter how obvious the bottom line is, sometimes we all need hammering the point home (particularly when violent market swings cause even the most seasoned investor to make stupid mistakes).

The book gets interesting from Chapter 36, where the author starts talking specifics, beginning with his 4-step advice: 1) decide on asset allocation (proportion of stock and bond funds in your portfolio) based on your risk tolerance, 2) open account with one or more prominent fund families (Vanguard, Fidelity, T. Rowe Price) to set the ball rolling, 3) choose specific stock and bond funds offered by these fund families to build your portfolio, and 4) rebalance twice a year to reset the proportion back to the original asset allocation.

In short, the author does the following:

1. First, he presents four different asset allocation types, with increasing degrees of risk (and return): low risk, medium-low risk, medium-high risk, and high risk. Your choice of asset allocation depends on your risk tolerance (that in turn depends on your age and other circumstances).
2. Next, he builds the portfolio for each asset type using three kinds of index funds – total US stock index fund (that tracks the broad US stock market), international stock index fund (tracks major international market indexes), and total US bond index fund (tracks broad US bond market) – drawn from each of the three fund families.
3. He wraps up by suggesting you rebalance your portfolio twice a year (opinions vary on this – I rebalance once a year), to reset your portfolio composition back to the original asset mix.

These specific advices will hand-hold a first-time investor through the process of setting up a well diversified portfolio that is guaranteed to achieve at least the market return. And, “over the long term, simply achieving market returns will beat 95% of all professionally managed investment portfolios”. To a newbie investor, this alone should be worth paying $19.95 for this book. If you are a pro, search the bargain shelves of your favorite book store – you may get lucky too.

You and I, as members of the household sector, want to invest our money, whereas the business sector wants to raise money to pay for real assets. Such supply and demand requirements create an atmosphere of synergistic interactions between these two sectors.

Financial intermediary – (1) Banks

The problem is that the size of a typical household investment is too small to meet the need of large businesses. I cannot lend Microsoft enough money to make a whiff of a difference to its finances. But, if funds are pooled together from a large number of households, businesses can then borrow from this substantial pool.

Thus, a financial intermediary can make a profit from the difference between the interest it charges the businesses (borrower) and the interest it pays the households (lender). This is exactly what a bank does. The mismatch of scales between the interests of household and business sectors allow banks to earn by providing a service that indirectly brings them together.

(2) Investment companies

Besides borrowing from banks, businesses also sell stocks and bonds directly to the investors. Here again, the smallness of household assets becomes a problem. An investor cannot often afford the substantial brokerage and trading costs to own a large number of securities from different companies (that is needed to adequately diversify his portfolio).

Investment companies, such as Vanguard, Fidelity and T. Rowe Price, have evolved from these mutual needs to sell and buy company securities. Like banks, they pull together funds from small investors and purchase a variety of securities. Each investor pays for shares of this composite holding, known as a mutual fund, which provides the necessary diversification. Part of the payment goes to the fund operators as management fees.

Investment banks

Unlike the banks and investment companies that serve as intermediaries between investors and businesses, investment banks provide services only to the businesses. Because firms issue stocks and bonds to raise funds, investment bankers such as Merrill Lynch, Goldman Sachs and Smith Barney advice them, for a fee, on the prices they should charge for these securities, prevailing market conditions, appropriate interest rates and so on. They also act as brokers in seeking out investors when new securities are issued.