When it comes to investing, my hero is John C. Bogle (a.k.a Jack).
In 1974 he founded the Vanguard company, an investment company owned by the fundholders and operated solely in their interests.
In 1976 he created the first index mutual fund available to the general public.
And he wrote many books to share his wealth of knowledge of investing.
One of his most popular books is The Little Book of Common Sense Investing. It is remarkably brief for the scope of material that it covers, but is immensely helpful.
In this post I want to share some of the best lessons and insights I gleaned from the book.
Big Ideas I Love From the Book
Passive Investors (As a Group) Always Beat Active Investors (As a Group)
Bogle points out that all investors together make up “the market.” So if the market returns 7%, all investors together earned 7%:
Well, you can split investors up into passive investors who invest in an index that track the market, and active investors who attempt to beat the market:
We know that passive investors—by definition—earn the same return as the market as a whole.
Active investing is a zero-sum game. Some active investors beat the market, but the winners win at the expense of losers losing. But taken together, active investors as a group have returns equal to the market as a whole. This is axiomatic. If the market averages 7%, and passive investors match the market at 7%, everyone else must also collectively earn 7%.
But here’s the rub, passive investors arrive at their returns while incurring the lowest possible costs, while active investors lose a considerable portion of their returns to fees.
So while each side receives the same gross returns, the side with the lower fees is guaranteed to receive the higher net returns.
Let’s assume that the active traders incur expenses of about 1.5% while passive investors face expenses of .04% (which is the expense ratio of VTSAX—Vanguard’s total stock market index find). Here are the net returns of each group of investors:
Which group would you rather be a part of?
“In the short run the stock market is a voting machine . . . in the long run it is a weighing machine.”
This is actually a quote from Benjamin Graham, the mentor of Warren Buffett.
It means that even though the stock market’s daily valuation is subject to the emotional logic of investors trying to predict the future, the market’s long-term growth has been fueled by the real growth of business.
Jack Bogle quantifies this through his own research. Out of the 9.5% average annual returns since 1900, Bogle shows that about 9% is driven by enterprise, and just 0.5% was generated by investor speculation.
In the long runs, it’s the earnings and dividends of businesses that account for almost all the returns of the stock market.
“Fund performance comes and goes. Costs go on forever”
Many people are tempted to invest in an actively managed fund with good recent performance in hopes of beating the market.
This strategy usually doesn’t work out too well. Not only are top-performing funds likely to come back down to earth, but investing in an actively managed fund likely comes with much higher costs.
The fees you incur when trying to beat the market are relentless. They hit you when you’re up, they hit you when you’re down. They are an ever-present drag on your portfolio. You take on 100% of the risk…and 100% of the cost. This is a great deal for your broker, but a lousy deal for you.
Related Post: The Tyranny of Compounding Costs: How Fees Eat Your Wealth
Be Careful of Reversion to the Mean
This is the other reason why you have to be careful trying to beat the market.
Most people look at a fund’s performance when deciding where to invest. They go with one that has had recent success, hoping the trend will continue. It rarely does.
A fund that’s had a hot streak is not likely to keep it up indefinitely.
Bogle did research where he grouped funds into quintiles by performance over a five year period, then tracked the funds for another five years. Here’s what happened to the funds that were originally in the top quintile during the subsequent five-year period:
- Only 13% remained in the top quintile
- 27% ended up in the worst quintile
- A quarter (25%) of them ended up in the next-to-worst (fourth) quintile
- 10% didn’t survive the next five years
Conversely, here’s what happened to some of the original losers:
- 17% ended up in the top quintile
- 12% stayed at the bottom
- 26% didn’t survive
So you’re not likely to win picking the recent studs, but you’re also not likely to win picking the recent dogs. There’s no reliable way to pick winners. The best bet for any fund is that it will be about average next year.
Asset Allocation is Crucial; But Yours Will Never Be Perfect
Bogle makes it clear that asset allocation is crucial. according to his research, 94% of the variation in returns can be explained by asset allocation.
But like so much in investing, the best asset allocation can only be determined in hindsight. This is something I struggle with, because I crave certainty where there is none.
But Bogle’s words provide me great comfort:
But allocations need not be precise. They are also about judgment, hope, fear, and risk tolerance. No bulletproof strategy is available to investors. Even I worry about the allocation of my own portfolio…
My own total portfolio holds about 50/ 50 indexed stocks and bonds, largely indexed short- and intermediate- term. At my age of 88, I’m comfortable with that allocation. But I confess that half of the time I worry that I have too much in equities, and the other half of the time that I don’t have enough in equities…
Finally, we’re all just human beings, operating in a fog of ignorance and relying on our circumstances and our common sense to establish an appropriate asset allocation.The Little Book of Common Sense Investing (Kindle Version) pg. 168-169
Related Post: Asset Allocation the Simple Way: How to Protect Your Wealth
Jack Bogle passed away in 2019. It’s a shame, because I really would have loved to get to meet him and thank him. It’s arguable that no one has done more to help regular ordinary investors than he did.
Anything by Bogle is worth reading, and this is probably the best book of his that I’ve read.
You can get it on Amazon here
Or, get the book for free with a free trial of Audible
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