Charge 'em for the lice, extra for the mice Two percent for looking in the mirror twice Here a little slice, there a little cut Three percent for sleeping with the window shut When it comes to fixing prices There are a lot of tricks he knows How it all increases, all them bits and pieces Jesus! It's amazing how it grows! Master of the House, Les Miserables
A neighbor sales rep for an investment management company called on me the other day. He described new products his company had recently launched, including several that exploited the depressed mortgage and bond markets. He even mentioned the dreaded CDO's. I must admit I was a bit lost by his discussion of derivatives, befuddled as well by claims of an almost riskless 8% net return, which would justify the steep fees. Why, I thought, if such a certain opportunity existed, wouldn't the company simply invest its own money? Deciding I wanted no part of what I didn't understand, I told my neighbor I'd just finished reading John Bogle's gem of a book: The Little Book of Common Sense Investment. His face turned ashen and the conversation quickly turned to sports.
Though we've never met, John (Jack) Bogle has been my personal investment advisor for almost 20 years. At the time, he was CEO of The Vanguard Group, an investment management company known for its low-cost mutual funds. Vanguard is unique in that the company is owned by the funds themselves, in contrast to other large public management companies. Vanguard is thus obsessed with fund investors rather than shareholders. Over the years, that difference has manifested in appreciably lower fees.
Perhaps Bogle's most enduring accomplishment has been the introduction of the first index mutual fund in 1976. An index fund passively holds stocks of all companies for a given market index, in this case the S&P 500. It also transacts infrequently, keeping the lid on trading fees. Over the years, this approach to owning the market has generated outstanding returns. And since there's little research, marketing and administration with index funds, the overall cost structures are much lower than than those of actively-managed cousins. No less an expert than economics Nobel laureate Paul Samuelson once noted: The creation of the first index fund by John Bogle was the equivalent of the invention of the wheel and the alphabet.
Bogle's pro-index fund arguments have been remarkably consistent over the years, looking something like the following:
- The aggregate returns of all companies in the stock market (the market) equal the gross returns of all investors.
- For each investor who produces returns superior to the market, there must be one or more whose returns are inferior.
- Net returns of investors differ from gross returns by costs incurred.
- The miracle of simple compounding arithmetic assures that returns multiply. That same compounding miracle, unfortunately, assures that expenses paid to manage portfolios multiply as well.
- At any given time, three quarters of costly actively-managed portfolio accounts under-perform comparable index funds even before expenses are deducted. Over longer time frames, that percentage approaches one. Returns net of expenses, of course, favor index funds even more.
- For the majority of investors, therefore, attempting to beat the market is a loser's game. Their best strategy is to buy and hold the market via low cost index funds.
I periodically revisit Bogle's wisdom not only to affirm my investment approach but also as a guide for BI. A driving tenet of Bogle's thinking is to keep things simple. He often cites Ocam's Razor, a dictum that prescribes to choose the simplest among multiple solutions. He also touts the relentless rules of humble arithmetic, quoting Sophocles: Remember O Stranger, arithmetic is the first of the sciences, and the mother of safety. Bogle doesn't use sophisticated forecasting and regression models to tell his index fund story, but his straightforward analyses with tables and graphs are as persuasive as any I've seen in BI. When I reach for my predictive modeling bag of tricks, I first ask: How might John Bogle analyze this problem? Is there an easier way?
Bogle's investment aphorisms are also cautions for BI. He regularly shows that the industry is easily fooled by randomness, chasing hot funds and managers who charge dearly for their skills that don't persist over time. Over the years, I've accumulated some of Bogle's wisdom. Among his maxims pertinent for measuring business performance and BI:
- We investors as a group get precisely what we don't pay for.
- Performance comes and goes, but costs are forever.
- The stars produced in the mutual fund field are rarely stars; all too often they are comets.
- The first shall be last. And they were.
- The greatest enemy of a good plan is the dream of the perfect plan.
I just put a note in my iPhone calendar to review Common Sense Investing again in six months.