Investing Basics

The Little Book of Common Sense Investing

by Max Kirouac CFA® – Investment Counsellor, BMO Private Banking

Jack Bogle doesn’t have the same level of name recognition as investment gurus like Warren Buffett and Benjamin Graham, but he has likely done more for the average investor than any of his more famous counterparts. Perhaps Bogle is occasionally overlooked because he did not focus on the allure of excess returns, but rather the tyranny of excessive fees. Bogle’s crusade against misinformation in the investment industry is concisely summarized in his 2007 classic (revised in 2017) The Little Book of Common Sense Investing.

The Little Book of Common Sense Investing is an ideal starting point for anyone wishing to expand their financial literacy. There are no get-rich-quick proclamations or vague anecdotes presented as “proof” of successful investment strategies. Instead, Bogle’s presents a clear message: the vast majority of investors should target the market return and ignore the cost-laden, inconsistent strategies preached by active fund managers. Bogle’s primary weapon is arithmetic, and he wields it effectively. By definition, all investors, taken together, earn the stock market’s return (before fees are deducted). Beating the stock market is therefore a zero sum game; for all outperformers, there must be corresponding underperformers. Since active managers as a whole can’t achieve returns that exceed market returns, their returns (after fees are deducted) must, taken as a whole, underperform the stock market. The numbers clearly bear this out.

All stock market participants are aware that investing involves costs: trading commissions, management fees, taxes, etc. The long-term goal is clearly to earn returns that are sufficiently greater than the costs of investing. The most appealing way to do so is to try to find ways to maximize returns by churning your account and buying positions in the hunt for short-term gains. Any market participants who have attempted this strategy (myself included) can attest to the sheer difficulty of picking winners. Professional money managers struggle just as mightily as DIY investors. A few staggering facts highlighted by Bogle in The Little Book of Common Sense Investing:

  • 90% of actively managed mutual funds underperform the S&P 500 in any given year.
  • There is no correlation between outperformance in one year and outperformance in subsequent years (indicating that a mutual fund outperforming the S&P 500 in any given year is largely a random occurrence).
  • $10,000 earning a 7% annual return for 50 years will grow to $294,600. The same $10,000 earning a 5% annual return for 50 years will grow to only $114,700. A 2% difference in annual return leads to a shortfall of $179,900. When the magic of compounding is involved, every percentage point matters.

Instead of naively trying to beat the market based on hot tips from your mailman or industry experts on CNBC, just make sure you’re earning your fair share of the market’s return by minimizing the costs of investing.

Given this reality, Bogle preaches navigating a different course. With this idea in mind, Bogle founded the Vanguard Group in 1975 and launched the world’s first index fund.

The index fund, as created by Bogle, was designed to be purchased, held forever, and forgotten about. The Vanguard S&P 500 index fund, with its extremely low cost (expense ratio of only 0.03%) is intended to exactly capture the returns of the S&P 500 net of its extremely marginal management fee. Sound boring? That’s exactly how Bogle thinks investing should be. As he says in the book, the time that would otherwise be spent fretting over investment portfolio construction can instead be “used in more productive and enjoyable ways”.

Notwithstanding its austere length of 111 pages, the evidence provided by Bogle in support of his strategies is extensive. Beyond espousing the superiority of passive indexing over active management, Bogle delves into asset allocation, rules for rebalancing, return forecasting, and the traits of good investment managers (despite his stance on active strategies, Bogle does believe there is a place in the industry for good investment managers).

A caveat: I believe strongly in most of what Bogle preaches, but I can’t bring myself to completely dismiss the allure of outperforming the market. I acknowledge that this is exceedingly difficult (historical mutual fund performance clearly indicates this), but I believe that Bogle falsely equates exceedingly difficult with impossible. I like to compare stock market outperformance with professional sports: if all of the world’s hockey players were plotted on a graph, the few that are talented enough to play in the NHL would be a statistical anomaly. Their talent makes them such outliers that statisticians would likely remove them from the data set so as not to skew results. And yet, these individuals exist. I believe the same statistically anomalous individuals exist in the investment industry. I would define myself as financially agnostic – I believe there are successful strategies out there, but I don’t know what they are or how to find them. In the meantime, I’m not prepared to sacrifice my savings on hunches, so I’ll stick with Jack Bogle’s lessons.

Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.

Max Kirouac
About Max Kirouac

Max Kirouac, CFA®, is an Investment Counsellor at BMO Private Banking in Winnipeg, Manitoba. If you would like to discuss this article more with Max, connect with him on LinkedIn.

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