By John Wasik
CHICAGO Aug 20 Some eight years ago, I was at a presentation by Vanguard founder Jack Bogle at a business journalists' conference in Denver, and when his PowerPoint crashed, and he had to use transparencies on a vintage 20th-century overheard projector. After the presentation, he let me keep them, and they still serve as a sort of Rosetta Stone for me for enlightened investing.
The slides outlined some truths in the fund business, ones that are well known but little heeded by investors: Hot money chases bubbles and gets in and out at the wrong times; investor net returns are lower than what most people think, and the outsized disparity between fund asset sizes and performance. Larger, actively managed funds don't often produce better returns at a lower cost.
Bogle, as the Godfather of index investing, has ideas that are timeless and based on simple math, and at the same time exhibit uncommon sense and a routinely overlooked view of how investors are consistently overcharged by the financial services industry. Fortunately, his wisdom is widely available to everyone.
Much of that wisdom has been assembled in Bogle's most recent book "The Clash of the Cultures: Investment vs. Speculation (Wiley, 2012)." While most of the insights are time-honored themes in the Bogle canon, they are very useful for individual investors.
1. Cost matters everywhere
This has been Bogle's mantra for decades. It emerged as an idea in his senior thesis at Princeton in 1949 and was one of the seeds for the creation of the Vanguard Group (Disclosure: My retirement portfolio is mostly in Vanguard funds).
His formula is simple: "gross market return. minus the cost of financial intermediation is the net return."
Boiled down, that means what you keep is the return of the investment, minus all of the fees managers and other middlemen load into your account. The math is always compelling. When the progressive think tank Demos did a study on 401(k)s earlier this year, it found that in the long run, the average stock mutual fund earns 7 percent, roughly matching the return of the stock market. When all fees were subtracted, however, the net return dropped to 4.5 percent. Expenses ate up one-third of returns, or about $155,000 over the working life (from 1965 to 2005) of an average American.
Bogle says you can always cut costs to boost returns, as nearly every mutual fund group offers low-cost index funds. Don't buy them through a broker and make sure they represent all asset classes (stocks, bonds, REITs, commodities) in your retirement plan. He writes: "If beating the market is a zero-sum game before costs, it's a loser's game after costs are deducted."
2. Speculation costs everyone
By Bogle's calculation, some 99.2 percent of the market is speculation-oriented trading, as opposed to investment where firms and individuals hold positions for years instead of nanoseconds. With robotic-trading machines and algorithms ruling the roost, does the little guy stand a chance?
Don't try to beat the speculators, who have a casino mentality, Bogle advises. Invest in the intrinsic "enterprise" value of companies and reap their dividends. Find low-cost indexes that represent everything from large companies to start-ups. Bogle found that this kind of passive investing beat active trading by 1.2 percentage points from 1976-2011. Trading costs are embedded in lower returns of actively managed funds, but not added into the expense ratio.
If you dig hard enough, you can find this expense, but it's difficult. Demos estimates that the average trading cost for retirement funds in 401(k)s is 1.2 percent. That's in addition to 1.27 percent annually for other expenses. So you're often taking a 2.4-percent haircut every year before you even see an investment return. "In the long run, investors win and speculators lose," Bogle writes.
3. The basic rules don't change
Bogle says fund managers may have lucky years, but eventually their returns revert to the market average. There's always risk in the securities market, so don't increase it by trying to time the market. Adjust your stock allocation as you get older - the percentage of bonds you own should roughly match your age. Don't invest based on last year's returns.
Even as the headlines trumpet any number of financial maladies and economic turmoil, Bogle is a voice of calm. "As the financial markets swing back and forth, do your best to ignore the momentary cacophony, and to separate the transitory from the durable. This discipline is best summed up by the most important principle of all investment wisdom: Stay the course!" Bogle says.
After all of this, what, you may ask, is "the course?" Start with an investment policy statement that puts in writing your goals, risk tolerance and allocation. If you can't go it alone, work with a fiduciary adviser or planner who doesn't buy and sell investments - they only provide advice and guidance. Then find or create a portfolio that's right for you. There are simple, pre-fab "lazy" portfolios at bogleheads.org, a website that offers "Investing advice inspired by the example of Jack Bogle."
As an investor who can make a difference by lowering investment costs and eschewing speculation, you won't be able to entirely defeat the "happy conspiracy" that Bogle says has been milking investors for decades. Yet if enough people run the numbers, take action and "stand up and be counted," you won't be a victim, you'll be a successful investor.