John Bogle Updates His Beliefs

Last Updated: December 9, 2009Posted in Individual Gurus, Individual Investing

In his 2009 book Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition, author John Bogle has “not altered a single word of the original edition, but [has] chosen instead to update its voluminous data, and to comment on significant developments that have occurred since then…”, [trying his] “best to be candid in describing occasions when experience confirmed [his] insights of a decade ago, and when experience failed to do so…” One significant development over the past decade is the growing availability and diversity of Exchange-Traded Funds (ETF) as substitutes for mutual funds. Some notable reflections from the book are:

From the “Preface to the 10th Anniversary Edition” (Pages xvi-xvii): “The principles that I set out in the 1999 edition remain intact — and then some. Yes, intelligent asset allocation–the appropriate balance of your portfolio between stocks and bonds–is key to success. Yes, simplicity rules. Yes, the stock market ultimately reflects the performance of the real economy and of corporate business, and of earnings growth and dividend yields. Yes, the costs of investing matter. (So do taxes.) Yes, passively managed low-cost stock and bond index funds continue to outperform their actively managed peers. And yes, the returns earned in the various investment sectors (including U.S. and international markets) still revert to the mean of the market or below. Yes, returns of individual funds also continue to revert to the market mean, as yesterday’s high-performing funds become tomorrow’s laggards.”

From Chapter 1, “On Long-Term Investing” (Pages 42-43): “Nothing that has happened in the last decade…persuades me to change a single one of those six rules of intelligent investing.” [Invest you must. Time is your friend. Impulse is your enemy. Basic arithmetic works. Stick to simplicity. Stay the course.]

From Chapter 2, “On the Nature of Returns” (Page 76): “The sources of equity returns remain: (1) investment (or fundamental) return, consisting of the initial dividend yield and plus the subsequent rate of annual earnings growth, plus or minus (2) speculative return, the annualized impact of the percentage change in the price that investors are willing to pay for $1 of earnings (the P/E ratio). In the long run, stock returns are driven by investment return, and speculative return–so important in the short run–fades away.”

From Chapter 3, “On Asset Allocation” (Pages 106-107): “…I was far too cautious in my estimates of mutual fund costs. …a central all-in cost figure could easily come to 2.5 percent annually…an astonishing 71 percent of an assumed 3.5 percent equity premium. …minimizing investment costs is part and parcel with minimizing portfolio risk.”

From Chapter 4, “On Simplicity” (Page 142): “‘To come down where you ought to be’ depends on your clear understanding of the value of ‘the gift to be simple,’ and its commonsense implementation.”

From Chapter 5, “On Indexing” (Pages 185-186): “Yes, it is possible, and reasonable, to buy an ETF that represents the S&P 500 or the total U.S. stock market, to hold it as a long-term investment, and to own it at low cost. …I endorse such a strategy. But such investing is the rare exception among ETFs. First, ETFs based on broad market indexes number only about 20, compared to some 700 narrowly focused funds… Second, buy-and-hold investors are conspicuous by their absence from the ETF scene. …Third, with a few exceptions (the Spider being one), ETFs, while bearing far lower expense ratios than traditional mutual funds, carry annual expense ratios that are three to four times the ratio of classic index funds…”

From Chapter 6, “On Equity Styles” (Pages 213-215): “In the long run,…the various styles of investing…have a powerful tendency to revert to the stock market mean. …Betting on styles is indeed a ‘strange game’ (and ultimately a loser’s game). …So how about staying out of the game, and simply relying on an index fund? Yes!”

From Chapter 7, “On Bonds” (Page 250): “In these uncertain days, bond funds are an especially important option for investors. Unlike stock funds, they have high predictability. … Municipal bond funds are fine choices for investors in high tax brackets, and inflation-protected bond funds are a sound option for those who believe that much higher living costs will result from the huge federal government deficits of this era. The greatest constant of all is that–given equivalent portfolio quality and maturity–lower costs mean higher returns.

From Chapter 8, “On Global Investing” (Pages 275-276): “I want to reemphasize my reluctance to embrace the idea of holding a true global portfolio, in which a U.S. investor’s market weighting would be based on the weights of the markets of each major nation, resulting, in mid-2009, in 44 percent U.S. stocks and 56 percent international stocks. But I have no reluctance whatsoever to emphasize a truly global strategy, focused largely on U.S. stocks. …I continue to believe it is not necessary to stray too far from home…and stick to my recommendation that international funds…not exceed one-fifth of an investor’s equity position.”

From Chapter 9, “On Selecting Superior Funds” (Page 301): “The evidence powerfully confirms that, at least in the mutual fund industry, the holy grail doesn’t exist. But investors seem hell-bent on carrying out the search for the winning funds of the future, no matter how futile the search has proven to be. ‘…index funds will continue to provide the last best chance for investors to earn…optimal investment returns.’ The events of the last decade simply add additional weight to that conclusion.”

From Chapter 10, “On Reversion to the Mean” (Page 328): “Everything that has happened during the past decade only confirms my earlier position that [reversion to the mean] in investing is everywhere… Ignore these clear lessons of history at your peril.”

From Chapter 11, “On Investment Relativism” (Page 344): “To believe that the higher mathematics of the brilliant quants that now permeate–directly or indirectly–our system of financial markets can consistently add value to investor returns is to fail to understand the self-correcting nature of the markets. Worse, the rise of mathematical models can easily give rise to an illusion of value creation that belies reality.”

From Chapter 12, “On Asset Size” (Page 371): “…it remains true that ‘size can kill.’ That problem is as relevant in 2009 as it was in 1999… It continues to be the the responsibility of the fund investor to carefully consider the problems created by giant fund size, and to avoid being trapped by them.”

From Chapter 13, “On Taxes” (Page 399): “…taxable investors owe it to themselves to emphasize passive index funds, or well-managed, low-turnover, actively managed mutual funds, or funds with substantial unrealized losses on their books.”

From Chapter 14, “On Time” (Page 422): “Time intersects with rewards, with risks, and with costs. And, yes, with the passage of time the magic of compounding returns is inevitably overwhelmed by the tyranny of compounding costs.”

From Chapter 15, “On Principles” (Page 444): “I continue to stand behind each and every principle of fund management that I stood for a decade ago, even as I’m disappointed that these principles continue to be honored more in the breach than in the observance…”

From Chapter 16, “On Marketing” (Page 464): “During the past decade, the fund industry has moved in precisely the opposite direction from the direction I urged. In the past two years alone, consumer advertising by mutual funds totaled nearly $1 billion (of your money). …We’ve moved a long way from our mission to serve investors.”

From Chapter 17, “On Technology” (Page 481): “…the self-inflicted damage [technology] has done to financial institutions and to fund investors has vastly outweighed its potential benefits and economies… …traders in indexed ETFs have earned returns that fall far below the returns earned by the respective indexes that the ETFs track. …All of this trading, when successful, engenders extra taxes, a large additional cost for active individual investors.”

From Appendix I, “Some Thoughts about the Current Stock Market as 2010 Begins ” (Pages 593-598): “…stocks are far cheaper (although not necessarily cheap). …we might be looking at an investment return on stocks of 6 percent to 8 percent over the coming decade. …I’d guess…that from current levels some combination of slightly higher earnings growth and/or a swift recovery of corporate dividends could bring the nominal return on equities–including both speculative and investment return–to between 7 percent and 10 percent during the decade ending in 2019. …equities, in my judgment, are currently valued at levels that suggest they should remain a significant portion of most portfolios…”

In summary, John Bogle continues to emphasize: (1) balance across stocks and bonds; (2) diversification through broad index funds; (3) funds with low costs; (4) avoidance of trading; (5) tax efficiency; (6) skepticism that hot fund managers will continue to outperform; and, (7) a long-term perspective.

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