The premise of the book is pretty straight forward, almost mathematical. While reading it I took notes, amazed every time by how simple arithmetic makes it all crystal clear. I'll revisit many of these topics in forthcoming blogs.
Beating the market is a folly. Fund managers compete to beat the market. But on average they achieve market performance minus their commission. Is there any reason to assume that your account manager or the few mutual funds you chose are better, or knows more, than managers of Pension funds, professional investment houses, etc? Not really. So why should they make more than their peers?
Picking "winners" is a loser game. Not necessarily because markets are perfect, but because for every "winning move" there's a corresponding "losing move" - if you buy, someone else is selling. Do you think you're smarter than the average investor, including thousands of people who do it as a profession? Personally, I don't think I'm that smart.
Real growth vs. Speculation. Market returns are a combination of the economy performance (“real growth”) and investors confidence/speculation, as measured in average P/E. The former has had a steady annual growth of 8-9% in the last 90 years. The latter just adds noise, and cancels over the years. There's no way to measure it and project it, so just ignore it. P/E swings change wildly decade to decade. They reached an all-time peak of 32 in 1999, to drop back to 18 in 2007 (compared with 14 at 1920). The stock market is a giant distraction. It masks the steady growth of the US economy with speculations and mood swings.
Emotions and Expenses are your enemies. Discipline and following a plan will control the emotions. Avoiding commissions and fees will reduce your expenses to a minimum. Management fees of 1-3% are joined by sale charges (loads), commissions, redemption loads, exchange fees, bid-ask spreads, and of course taxes since the turn over of actively managed funds is high. The total cost of an active fund becomes 3-3.5% annually. Over the years, with compounding, this translates to a staggering loss of more than 50% of your money.
Index funds. Investing in index funds minimizes commissions and takes away the emotional problem of deciding when to buy or sell. You just buy a large index fund and forget about it, until you have money to buy some more. The S&P 500 is a great representative of the US economy, as it covers about 80% of it. Bogle recommends a broader fund, such as Dow Jones Wilshire Total Stock Market Index (formerly called Wilshire 5000) which is still 80% S&P 500. However, the two strongly correlate. From 1930 to 2007 they're produced identical returns. From 1920 to 2007 the difference is 0.1% annually. Over a short period one of them may produce better returns. The main advantage of the bigger fund is reduced volatility.
Passive vs. Active investments. Over the last 20 years, the S&P 500 beat 58% of the large-cap mutual funds. In fact, the situation is better since these comparison does not include funds that were so bad as to go out of business (“survivor-biased”). Passive investment through index funds that track the US market will therefore beat the majority of managed accounts and mutual funds.
Chasing past performers is a folly. Morningstar rating are largely based on performance from recent 3-5 years. People who follow this advice will buy funds that already have had their run. For example, the top 10 funds of the late 90s made 60-70% annually. Taking into account 2000-2002, they all dropped to the lowest 5% of all funds. Even worse – since investors tend to join these funds after they've “proved their success”, the dollar return of these funds is much worse than the fund return. For example, the #1 fund in this list made 13% in 1996-2002, but the average investor made -62% (i.e., this is the dollar weighted gain of the account). This is because the average investor joined the fund after it had its big run.
Reversal to the Mean. #1 fund of 1982-1992 was #100 the following year (a bit above average). #1 of 1995-2005 was #942 the following year (outpacing only a third of the other funds). This phenomenon (Reversion to the Mean) causes funds with good performance over a few years to decline afterwards and join the average lackluster performance.
Index funds win in "inefficient" markets too. S&P reports that the international index outpaced 80% of actively managed international equity funds. Similarly, the Emerging Markets Index outpaced 88% of emerging markets funds. People don't use Index funds since they want to feel they have control over their finances. With Index funds “ship and pray” method, one is encouraged to give up control and let the market forces do their work.
Endorsements. These recommendations are endorsed by 3 Nobel price laureates, investors such as Warren Buffet and mutual funds managers such as Charles Schwab. It's especially funny to read Schwab's comments: while he's selling bazzilions of expensive, exploitive mutual funds to his customers, he freely admits that he invests his own money in index funds. Go figure!
Highly recommended - have I said that already? Go get a copy now.
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