The Little Book Of Common Sense Investing | John Bogle
The Little Book Of Common Sense Investing
Sieve through investment opportunities to uncover gems that will generate sizeable returns
There are lots of opportunities to make a sizable profit from your investments. However, this does not mean that the risk of losing a substantial %age of your funds does not exist. You will need a winning strategy to stay one step ahead of the financial market. Hence, John Bogle, suggests that you should consider a safe investment strategy that would allow you to own the country’s publicly held companies. By doing so, you are sure that your investment would generate returns as these businesses experience growth.
Index funds function as baskets of stocks that track and mimic the performance of the market. History has shown that the market always wins, just as the house always wins in the gambling world. There’s no finality when it comes to the stock market. It’s a gamble that relies on many factors, some of which are beyond your control. Once you accept this fact, it becomes easier to plan well.
The real money in investment will have to be made — as most of it has been made in the past — not out of buying and selling but of owning and holding securities, receiving interest and dividends and increases in value.
Investing in index funds improves profitability and eliminates practices that obliterate the money that you earn
It makes sense to bet on an investment portfolio that is broadly diversified across all, or almost all, of the nation’s businesses since they have collectively generated a 9.5% annual return on their capital over the last century. When this profit rate is compounded over 5 decades, every $1 initially invested in a fund that tracks the performance of the market as a whole, would earn $93.48 in five decades. Note that these statistics do not take into account the effect of inflation. Such practices or miscellaneous include the commission or fee paid to the intermediaries (investment bankers, brokers, lawyers, accountants, and money managers) and the amount that goes to tax.
Since the index funds are passive, you do not need to actively engage with the market, or require the need of services of custodial firms and legal practitioners.This approach beats the popular stock market game that entails that investors monitor the market closely to ascertain the best time to buy or sell stocks. The transaction costs incurred by adopting this strategy considerably slash the returns on such trades.
Knowing when to invest, and what to invest on is what separates a great investor from an amateur investor.
Do not be distracted by the speculative nature of the stock market. While comparing the long – term performance of the stock market compared to the returns business corporations generate, historical data from both investment vehicles differ by only 0.1%. The annual return from the stock market from 1900 through to 1999 stood at 9.6% while that of the investment return through the same period stood at 9.5%. Hence, the stock market mirrored the investment return from earnings growth and dividend yields throughout this period, with the great depression of the 1930s serving as one of the exemptions to the rule. While this is a given, it further solidifies the argument that the stock market return is not superior to investment return as popularly advertised. The 0.1% that separates the latter from the former is the result of speculation.
Did you know? According to Don't Quit Your Day Job (DQYDJ), an American business company, there are at least 13,665,475 accredited investor households in America
The stock market induces frenzy and greed that influences how much people are willing to buy or sell stocks
Emotionally induced price swings are responsible for short–term rise and fall of prices. The expectations of the stock market investors would do nothing but distract you from the real game that you should fixate on — that is the value of the real market. When you include the cost ineffectiveness of this investment strategy, it becomes clear that the stock market might not be ideal for you.
Bearing this in mind, it becomes sensible to bet on the market by diversely owning America’s businesses. You might think that the simplicity of this notion could sound counterintuitive. However, once you consider the returns that their dividends and earning growths could generate for you and the opportunities that the index funds bring to the table, there is no way you would settle for less.
Greedy investors buy what they think is best at the moment while great investors wait for the best moment to buy what they think is great.
Rather than handpick stocks and bear the brunt of the chances of losing to the market, you should invest in stock markets portfolios such as Standard & Poor’s 500 Index (the S&P 500). This index, which came into existence in 1926, mimics the stocks of 500 of America’s largest corporations and represents 80% of the market value of the stock market. Another standard measure of the stock market is the Dow Jones Wilshire Total Stock Market Index formulated in 1970 and that tracks 4,971 stocks including the 500 stocks that S&P 500 mimics.
Various factors could cause an investment to incur loss or that could devalue its profits
Of all the factors that can lead to a devaluation of any portfolio, perhaps the most common — and the most overlooked — is the cost of investing. You wouldn’t come across this sort of forewarning because the powers that be are the ones raking in the money that you spend to trade.
The intermediaries are financial powerhouses, and they would rather keep making money than let you see the light. More so, we often fail to realize that these middlemen are always on the winning side, even though you made profits or had a bad streak in the market. For instance, an average investor that holds stock directly would likely spend 1.5% on transaction costs per year. On the other hand, investors that engage with the market quite frequently would pay as high as 3% yearly.
While these figures seem inconsequential, they become an issue, especially if you choose to view the effects it would have on the long–term return you generate on your investments. Here, John Bogle lists 3 factors that might blind you to the downsides of exorbitant financial intermediation.
First, intermediaries have become adept at hiding the cost of investing in plain sight. In other words, it is almost impossible to unravel the inside workings of these festering systems and how it slowly eats away your profits. Second, you could become blind to these scourges if the stock market is performing beyond your expectation. And so, profit, irrespective of how much you have lost to the middlemen, seems reasonably satisfying.
Third, you could overlook the implications of trading costs when you prioritize short–term investment goals to long–term ramifications. Emotion–based penalties are another discrepancy that separates the return equity mutual funds record and the return mutual funds investors earn. In addition to the cost of investing, investors often get burned as a result of bad timing and adverse selection.
To mitigate the risks of the stock market, go for the index funds that eliminate the pitfalls of emotional–based investment decisions that short–term market swings usually motivate.
It is impossible to ignore the diminishing effect of federal, state and local income tax laws when discussing the downsides of mutual funds relative to the index funds
Ignoring the effects of tax laws is essential to any business growth. For one, the shift from long–term to short–term trading has had a direct impact on the turnover rates of mutual funds. As such, it is safe to say that the practice by active managers of responding to market swings would undoubtedly contribute to the taxes income of investors.
In contrast, the index funds obey an opposing principle that value lifetime investment, which reduces transaction cost infinitesimally and eliminates the tax burdens that could devalue the return on investments. For instance, although the net annual return of an average equity fund generated from 1996 through to 2005 is 8.5%, data shows the tax bill accounted for 1.7% of this return.
Therefore, the factual net fund return had dropped considerably to 6.8%. When you add the effects of tax obligations on returns, the operating costs of actively managing your investments, and inflation, it becomes easy to see the wisdom that backs an investment strategy that relies on passivity and compounded long–term return. This argument is potent in cases where the returns on actively managed funds are not as profitable as expected.
To counter the effect of tax, inflation and operating costs, investors often try to pick winning funds based on long–term records, rather than speculations.
Become a winning investor requires knowing when to take risks and when not to
Recall from the previous chapter that John Bogle revealed that some investors believe that choosing winning equity funds based on their past performances could help them stay ahead of the game. As valid as this sounds, it is imperative to dissect this argument to determine how effective the records of mutual funds would project a favorable future. To ascertain the validity of this notion, it is necessary to analyze the historical data showing the performances of the 355 equity funds that came into existence in 1970.
Only 132 of these 355 equity funds still exist today. More concerning is the fact that 60 of the fully–operational 132 have underperformed when compared to the S&P 500. Also, 48 funds fall within the plus or minus one percentage point of the return on the S&P 500, whereas, just 24 could outperform the stock market with a percentage point greater than one. Moreover, only 9 funds out of the 24 could boast of a return that outpaced the market annually by over 2 percentage points.
Judging from the inability of a significant fraction of the selected 355 equity funds to sustain a winning streak, it is safe to say that pinning all your hope on finding a winning investment fund is not a smart investment strategy. There are just too many factors that could derail the performance of a fund. For instance, the fund managers are bound to change, or a marketing company could acquire the management firm in charge of the fund and dissolve it.
Finding a fund that could win in the long–term is a gamble, since other factors beyond your control could force the fund to go out of business.
While borrowing from the events that led to the market bubble between 1997 through 1999, John Bogle explains that short–term returns are perhaps one of the major contributors to the fear–of-missing–out frenzy that makes investors throw caution to the wind. Bearing this in mind, it is advantageous that you fight the urge to chase short–term high–flying funds, particularly when the market is on a bull run.
Consulting professionals may or may not work for your investment endeavors
Getting professional advice from expert investors could add to your understanding, and it might warn you of the risks of picking funds with impressive performances in a short time frame. However, in most cases, investors employ the help of brokers and investment advisers because they cannot decide on funds that best suit them. And so, they pay fees or commissions to experts that appear to have all the right answers.
Hence, statistics show that 70% of 55 million American families who have in one way or the other invested in mutual funds do so through the help of middlemen. And while you would expect that hiring individuals that supposedly should have nurtured above–average investment skills will improve your earnings; a study concluded that the underperformance of funds that brokers recommend from 1996 through to 2006 costs investors a staggering $9 billion annually.
Furthermore, the study showed that investors who had handpicked their funds and allocated their assets themselves earned more money than investors that relied on investment advisors. Besides, the idea of brokers–managed funds often does not add value to investors. For one, brokers' commitment to selling their firm’s investment product poses a conflict of interest, since investors’ interest is not the sole reason why they make recommendations.
You must consider professional advisors with reasonable investment advisory fees, which you will deduct from your yearly return.
Favor professional advisors who recommend low–cost funds that are not as risky as high–cost funds
While some index funds have no load fees, many have front–ends with an option for the investor to pay the fees through 5 years. Though these extra costs could seem harmful at first, the compounded effect of these fees could diminish your return significantly. Take for instance the case of the first index fund in history, Vanguard 500 Index Fund, and the second, Wells Fargo Equity Index Fund.
If low–cost is a critical criterion for making sound investment decisions, then going for index funds that guarantee the lowest costs is the ideal choice.
This assertion is true because such funds do not need active management. However, you should understand that not all index funds carry the same low – cost feature. Vanguard and Wells Fargo both tracked the performance of the S&P 500 Index. However, they run on differing expense ratios. For Vanguard, its expense ratio dropped considerably over the years from 0.28% annually to 0.18%, and 0.09% for investors that had invested more than $100,000 in the fund. On the other hand, Wells Fargo Equity Index fund had an initial sales commission of 5.5%, and its expense ratio over the years averaged 0.80%.
This varying cost meant that Vanguard returns had more value than that of Wells Fargo. As such, a $10,000 investment in the Vanguard 500 would have yielded $122,700 compared to the $99,100 the same investment would have yielded if invested in Wells Fargo Equity Funds for the same timeframe.
The bond market has many downsides that you must pay attention to because some are inevitable
The previous chapters have relayed to you the superiority of the index fund over the mutual funds. In this chapter, the viability of index funds to the bond market will be compared. Recall that the features that set the index fund apart are its passive nature, the low costs it affords investors, and the stability of expected returns. These same advantages come to play when relating the efficacy of index funds to that of investments that rely on the interest rates of bond funds and Exchange–Traded Funds (ETFs).
Managers of bond funds add an increment to the return on investments by tracking and betting on the market’s interest rates. In other words, they must guess when bonds are going to spike, so they could determine when to buy and the time to sell. As you would expect, this sort of investment strategy carries risks, high investment costs, and the returns are not all that impressive.
In light of this discouraging factor, you should adopt index bonds, instead of actively managed bonds. The former holds a portfolio that comprises 50% corporate bonds and 50% U.S. government bonds. In contrast, the latter represents 25% corporate and 75% government bonds. In terms of viability, the bond index fund offers investors low–cost investments, minimal turnover, and long–term focus, which inevitably cancels out the operating costs that could limit returns.
Indexes are reliant on the value of the market or market sector they track, so logic suggests that an index fund would never outpace its underlying market.
As such, this revelation should encourage you to suspect index fund managers who promise to outperform the market for higher investments fees. In the case of ETFs, although they offer low–costs and long–term investments, the financial industry has used them to induce schemes that are somewhat similar to running equity funds. The initial long–term focus of ETFs has slowly transformed into short–term, actively managed, and cost incurring investment vehicles. As a result, the yearly turnover of Standard & Poor’s Depositary Receipts (SPDRs), the first–ever ETF, is 3,600%, while that of NASDAQ Qubes stands at 6,000%.
0 Comments