Contents
Introduction
Common Sense
Title Page
Copyright Page
Dedication
Foreword
Foreword for the Original Edition
Preface to the Original Edition
Acknowledgements
Acknowledgments for the Original Edition
About the Author
Part I - ON INVESTMENT STRATEGY
Chapter 1 - On Long-Term Investing
Chapter 2 - On the Nature of Returns
Chapter 3 - On Asset Allocation
Chapter 4 - On Simplicity
Part II - ON INVESTMENT CHOICES
Chapter 5 - On Indexing
Chapter 6 - On Equity Styles
Chapter 7 - On Bonds
Chapter 8 - On Global Investing
Chapter 9 - On Selecting Superior Funds
Part III - ON INVESTMENT PERFORMANCE
Chapter 10 - On Reversion to the Mean
Chapter 11 - On Investment Relativism
Chapter 12 - On Asset Size
Chapter 13 - On Taxes
Chapter 14 - On Time
Part IV - ON FUND MANAGEMENT
Chapter 15 - On Principles
Chapter 16 - On Marketing
Chapter 17 - On Technology
Chapter 18 - On Directors
Chapter 19 - On Structure
Part V - ON SPIRIT
Chapter 20 - On Entrepreneurship
Chapter 21 - On Leadership
Chapter 22 - On Human Beings
Afterword
Appendix I - Some Thoughts about the Current Stock Market as 2010 Begins
Appendix II - Some Thoughts about the Current Stock Market as 1999 Begins
Notes
Index
Don't Count on It
Title Page
Copyright Page
Dedication
Foreword
Introduction
A Note to the Reader
Part One - INVESTMENT ILLUSIONS
Chapter 1 - Don’t Count on It! The Perils of Numeracy
Chapter 2 - The Relentless Rules of Humble Arithmetic
Chapter 3 - The Telltale Chart
Chapter 4 - A Question So Important That It Should Be Hard to Think about ...
Chapter 5 - The Uncanny Ability to Recognize the Obvious
Part Two - THE FAILURE OF CAPITALISM
Chapter 6 - What Went Wrong in Corporate America?
Chapter 7 - Fixing a Broken Financial System
Chapter 8 - Vanishing Treasures: Business Values and Investment Values
Chapter 9 - A Crisis of Ethic Proportions
Chapter 10 - Black Monday and Black Swans
Chapter 11 - The Go-Go Years
Part Three - WHAT’S WRONG WITH “MUTUAL” FUNDS
Chapter 12 - Re-Mutualizing the Mutual Fund Industry: The Alpha and the Omega
Chapter 13 - A New Order of Things: Bringing Mutuality to the “Mutual” Fund
Chapter 14 - The Fiduciary Principle: No Man Can Serve Two Masters
Chapter 15 - Mutual Funds at the Millennium: Fund Directors and Fund Myths
Chapter 16 - “High Standards of Commercial Honor . . . Just and Equitable ...
Part Four - WHAT’S RIGHT WITH INDEXING
Chapter 17 - Success in Investment Management: What Can We Learn from Indexing?
Chapter 18 - As the Index Fund Moves from Heresy to Dogma, What More Do We Need ...
Chapter 19 - “The Chief Cornerstone”
Chapter 20 - Convergence!
Part Five - ENTREPRENEURSHIP AND INNOVATION
Chapter 21 - Capitalism, Entrepreneurship, and Investing: The 18th Century ...
Chapter 22 - Seventeen Rules of Entrepreneurship
Chapter 23 - “Vanguard: Saga of Heroes”
Chapter 24 - When Does Innovation Go Too Far?
Part Six - IDEALISM AND THE NEW GENERATION
Chapter 25 - Business as a Calling
Chapter 26 - The Right Kind of Success
Chapter 27 - “This Above All: To Thine Own Self Be True”
Chapter 28 - “Enough”
Chapter 29 - If You Can Trust Yourself . . .
Chapter 30 - The Fifth “Never”
Chapter 31 - “When a Man Comes to Himself”
Part Seven - HEROES AND MENTORS
Chapter 32 - Walter L. Morgan
Chapter 33 - Paul A. Samuelson
Chapter 34 - Peter L. Bernstein
Chapter 35 - Bernard Lown, MD
Index
Praise
The Little Book of Common Sense
Little Book Big Profits Series
Title Page
Copyright Page
Dedication
Introduction
Chapter One - A Parable
Chapter Two - Rational Exuberance
Chapter Three - Cast Your Lot with Business
Chapter Four - How Most Investors Turn a Winner’s Game into a Loser’s Game
Chapter Five - The Grand Illusion
Chapter Six - Taxes Are Costs, Too
Chapter Seven - When the Good Times No Longer Roll
Chapter Eight - Selecting Long-Term Winners
Chapter Nine - Yesterday’s Winners, Tomorrow’s Losers
Chapter Ten - Seeking Advice to Select Funds?
Chapter Eleven - Focus on the Lowest-Cost Funds
Chapter Twelve - Profit from the Majesty of Simplicity
Chapter Thirteen - Bond Funds and Money Market Funds
Chapter Fourteen - Index Funds That Promise to Beat the Market
Chapter Fifteen - The Exchange Traded Fund
Chapter Sixteen - What Would Benjamin Graham Have Thought about Indexing?
Chapter Seventeen - “The Relentless Rules of Humble Arithmetic”
Chapter Eighteen - What Should I Do Now?
Acknowledgements
Introduction
I have dedicated my longcareer to building a better financial world for investors. Whether it was creating the nation's only truly mutual mutual fund company or creatingthe index fund, I've done my utmost to keep the best interests of investors as my chief priority. I've now written 10 books covering a wide range of topics-attempts to help individual investors make sense of the financial markets, the creation of The Vanguard Group, the failures of our nation's financial system, and the wisdom of long-term investment and the folly of short-term speculation. But the theme of fiduciary duty to investors-the idea that the client's interests must always come first-has been at the heart of all of my books, and the three included in this e-Book bundle are no exception. Why bundle these three books together? The Little Book of Common Sense Investing provides a simple, straightforward approach to investing; Common Sense on Mutual Funds is more complex, but reinforces many of the same themes; and Don't Count on It! puts those themes in a broader context while giving the reader the ability to browse through a variety of speeches on different topics.
The Little Book of Common Sense Investing
We know that in every investment transaction, there is a winner and a loser.One party is (relatively) enriched, while the other is (relatively) impoverished.But the financial intermediaries in the middle-the croupiers, as it were-take their share of every trade.So, in aggregate, investing is a zero-sumgame before costs, but it is a loser's game after costs. The only way to guarantee your fair share of the market's return is to minimize costs and own the entire market, thereby diversifying away the risks associated with individual stocks, sectors, and styles.
Clearly, low-cost, broad-market index funds are the easiest and most efficient way to implement this strategy. They take full advantage of the magic of compounding returns by keeping intermediation costs at rock-bottom, thereby avoiding the tyranny of compounding costs. These ideas are at the heart of my 2007 book,The Little Book of Common Sense Investing.In it, I attempt to explain the workings of the financial system in a way that will transform how readers approach investing. Those investors who leave the financial casino and opt for broadly diversified, long-term, low-cost index funds are virtually guaranteed to receive their fair share of the market's returns.By minimizing the drag caused by unnecessary intermediation costs and diversifying away uncompensated risks, we allow the productive power of our nation's economy to work its magic in gradually building the intrinsic value of our investments.
Common Sense on Mutual Funds-Fully Updated 10thAnniversary Edition
The first edition of Common Sense on Mutual Funds was published in 1999.In that original book, my primary goal was to help readers become more successful investors. I'd like to think that I largely achieved that goal. The fundamentals of investing that I set forth have been confirmed-and then some. The keys to investment success that I outlined-focusing on low-cost, broadly diversified index funds as the core of your portfolio, making intelligent asset allocation decisions, keeping it simple, understanding that the intrinsic value of corporate business drives investment success over the long term-remain true today. Well into the future, these "relentless rules of humble arithmetic" are bound to hold true.
In this fully updated and revised edition of Common Sense on Mutual Funds, I had the audacity to leave the text of the original 1999 edition essentially untouched, and brought it up to date with refreshed data and additional commentary throughout. The rules I offered in the original had been surely reaffirmed, even though it was written near the stock market's high in 2000 and the new edition was penned shortly after the market's low in 2009. Assets managed by the mutual fund industry now exceed $12 trillion and the industry has become the dominant vehicle for individual investors and those saving for retirement. But the old rules of long-term prudent investing remain intact.
My secondarygoal was to make the mutual fund industry a better place for investors. Alas, that goalremains out of reach. We've seen marketing and salesmanship continue to dominate stewardship. We've seen fiduciary duty too often ignored.And our nation's corporate governance structure continues to serve the interests of corporate managers and investment managers, rather than investors.The rules for investment success remain clear, and I am confident that, in the long-run, the interests of investors will again be paramount. For, as Winston Churchill reminds us, Americans always do the right thing, "but only after they've tried everything else."
Don't Count on It!
As the fiduciary principles on which the mutual fund industry was founded have eroded, we moved from a professional culture focused on the interests of investors to a business culture in which the "bottom line" is all that matters. In today's bottom line society, too often we seek the wrong bottom line: money over achievement, form over substance, charisma over character, prestige over virtue, the ephemeral over the enduring. I explore these topics in my 2011 anthology Don't Count on It!I also explore the shortcomings of the mutual fund industry, the proven success of indexing, my views on entrepreneurship and idealism, and tributes to four of my personal heroes and mentors. The book is a collection of 35 speeches and essays that I've written over the years.While it may seem intimidating, the book gives browsers the ability to seek out those areas in which they have a particular interest.
Our society's focus on and trust in numbers, with little regard to how easy they are to manipulate, is a common theme throughout the book. Far too often, we focus on momentary, fleeting stock prices-which can be measured precisely-rather than durable, intrinsic value-which is as real as it is difficult to measure. I'm reminded of Einstein's observation that "Not everything that counts can be counted, and not everything that can be counted counts." I describe the catastrophic consequences that occur when we place too much emphasis on these illusory numbers and let ourselves be fooled into thinking that past market returns are prologue; that mutual funds, on average, can be above average; and that corporate financial reports actually represent economic reality.
Timeless Wisdom
The themes expressed in these three books are timeless. They were critical when I first wrote them, they are still critical today, and they will remain critical tomorrow and well into the future. The importance of observing fiduciary duty, putting the interests of clients first, and the fundamental soundness of indexing are the foundation upon which I've built my career. As Confucius said, "By three methods may we learn wisdom.First, by reflection, which is noblest; second, by imitation, which is easiest; and third, by experience, which is bitterest." Let us not forget the wisdom we have gained through the bitter experience of recent years, for only then can we set our financial system and our society in general on a path to continued prosperity.
Table of Contents
Praise
Title Page
Copyright Page
Dedication
Foreword
Foreword for the Original Edition
Why This Book Is Unique
Preface to the Original Edition
“Common Sense” Defined
A Five-Part Approach
Common Sense Redux
Principles and Practices
Acknowledgements
Acknowledgments for the Original Edition
About the Author
Part I - ON INVESTMENT STRATEGY
Chapter 1 - On Long-Term Investing
Chance, the Garden, and Long-Term Investing
How Has Our Garden Grown?
Stock Market Returns
Bond Market Returns
Planting Seeds for Growth
The Financial Markets Are Not for Sale
Practice Departs from Principle
Simple Principles for Long-Term Success
Chapter 2 - On the Nature of Returns
Occam’s Razor and the Stock Market
Occam’s Razor and the Bond Market
Precision and Perversity
How Important Is It to Forecast Future Returns?
Chapter 3 - On Asset Allocation
From the Talmud to Modern Portfolio Theory
Risk to the Fore
Benefiting from Balance
A Third Dimension
Financial Scripture
Three Perspectives on the Impact of Cost
Is It Cost or Asset Allocation?
Chapter 4 - On Simplicity
When All Else Fails, Fall Back on Simplicity
Simplicity in Your Stock Portfolio
Rule 1: Select Low-Cost Funds
Rule 2: Consider Carefully the Added Costs of Advice
Rule 3: Do Not Overrate Past Fund Performance
Rule 4: Use Past Performance to Determine Consistency and Risk
Rule 5: Beware of Stars
Rule 6: Beware of Asset Size
Rule 7: Don’t Own Too Many Funds
Rule 8: Buy Your Fund Portfolio—and Hold It
The Paradigm of Simplicity
Part II - ON INVESTMENT CHOICES
Chapter 5 - On Indexing
Indexing Is a Long-Term Strategy
The S&P 500 Index Is Not the Market
Indexing Wins Largely Because of Cost
The Index Fund Is Much Better Than It Appears
The Thorny Issue of Risk
All Index Funds Are Not Created Equal
Indexing Works in All Markets
The Triumph of Indexing
Chapter 6 - On Equity Styles
Enter Tick-Tack-Toe
Comparing Apples to Apples
Equity Funds—Risks, Returns, and Costs
God, Pascal, and War Games
Chapter 7 - On Bonds
Misery Loves Company
A Flagrant Example
How Much Does Cost Matter?
What about Management Skill?
Sales Charges Exacerbate the Cost Issue
How to Avoid Excessive Costs
Chapter 8 - On Global Investing
The Global Portfolio Extreme
Currency Risk—and Returns
The Global Efficient Frontier
International Economies and Financial Markets
The Record of Global Investors
Constructing Your Own Global Portfolio
Indexing in International Markets—A Better Way?
The Accidental Tourist
“Acres of Diamonds” Revisited
Chapter 9 - On Selecting Superior Funds
The Equity Fund Record
Enter the Index Fund
The Index Fund Elicits a New Industry Mantra
Selecting Winning Funds—An Academic Activity
Funds That Have Beaten the Market—The Disappointing Reality
The Investment Advisers Who Select Funds—Another Disappointment
Returns of Funds of Funds—Yet Another Disappointment
No Holy Grail Here—Academic or Pragmatic
Part III - ON INVESTMENT PERFORMANCE
Chapter 10 - On Reversion to the Mean
Mutual Fund Champions Come Down to Earth
Gravity and Stock Market Sectors
Common Stocks Return to Earth, Too
Investing to Cope with the Force of Gravity
The Crown Jewels
Chapter 11 - On Investment Relativism
A Powerful Bogey
The Rise of Closet Indexing
The Index Fund: Villain of the Piece?
We’re All Quants Now
Measuring Managers—Where Does Your Manager Stand?
“If You Can’t Beat ’Em, Join ’Em”
Chapter 12 - On Asset Size
Isn’t Bigger Better?
Size and Fund Investment Returns
Real Size, Real Problems
What’s Size Got to Do with It?
Nothing Does Succeed Like Success—for Fund Managers
To Dream the Impossible Dream
You Can Make the Dream a Reality
Chapter 13 - On Taxes
Taxes—The Industry’s Black Sheep
Alpha Takes Another Hit . . . from Taxes
Fund Portfolio Turnover Soars
Fund Manager Turnover Doesn’t Help
A Good Solution: The Index Fund
A Better Solution: The Tax-Managed Fund
A New Idea, Sixty Years Old
Tax Strategies
The Parallax View
Chapter 14 - On Time
Reward—The First Dimension
Risk—The Second Dimension
Cost—The Third Dimension
Time—The Fourth Dimension
The Dimensional Imperative
Part IV - ON FUND MANAGEMENT
Chapter 15 - On Principles
Distribution Drives the Industry
Management versus Distribution
Information That Can Make a Difference in Your Fund Investments
Esperanto-Type Cranks
Chapter 16 - On Marketing
Your Money Is No Object
12b-1 Fees—Full Disclosure
Hawking Products, Hiding Risk
Owners versus Customers?
The True Business—Gathering Assets
Chapter 17 - On Technology
Investment Technology—Bigger, Quicker, and More Complex
Information Technology—Information versus Wisdom
Transaction Technology—Switch When the Iron Is Hot
The Report Card
The Pervasive Impact of Technology
Chapter 18 - On Directors
The Levers of Control
The Consequences of Control
What the Law Says
An Alternative Structure
Legal Action Coming?
Congress and the SEC
Summing Up
Chapter 19 - On Structure
Contrasting Ownership Structures
History in the Making
Strategy Follows Structure
Looking to the Future
The Information Age to the Rescue
Revision or Restructuring?
Part V - ON SPIRIT
Chapter 20 - On Entrepreneurship
I Meet a True Entrepreneur
A Merger, a Firing, an Idea
Steps and Stumbles
Schumpeter Describes the Entrepreneur
A Slice of the World in Context
Chapter 21 - On Leadership
The Majesty of Simplicity
A Fortuitous History
Readiness and Foresight, Purpose and Passion
Servant Leadership
Failure and Determination
Patience and Courage
Fate Takes a Hand
Chapter 22 - On Human Beings
The Investor as Human Being
Shareholders Respond
The Vanguard Crew
The Award for Excellence: Even One Person Can Make a Difference
Partnership: Sharing the Fruits of Our Labors
The Golden Rule
Afterword
Appendix I - Some Thoughts about the Current Stock Market as 2010 Begins
Appendix II - Some Thoughts about the Current Stock Market as 1999 Begins
Notes
Index
Praise for the original edition of
Common Sense on Mutual Funds
“Cogent, honest, and hard-hitting—a must-read for every investor. Bogle does the American investor a real service by carrying on his crusade. Absolutely terrific, particularly Part IV, ‘On Fund Management.’ I hope some journalists and the SEC get energized after reading it.”
—Warren E. Buffett
Praise for the tenth anniversary edition of
Common Sense on Mutual Funds
“Jack Bogle gave the public two magnificent gifts—Vanguard . . . and Common Sense on Mutual Funds, a readily accessible guide on how to manage personal investment portfolios. Take advantage of Jack Bogle’s gifts and pass them on to someone you love.”
—David F. Swensen, Chief Investment Officer, Yale University
“We don’t know who first invented the wheel. But the one and only inventor of the first index mutual fund—broadly diversified and investor-friendly—was John Bogle. If you will read only one book on canny personal investing, don’t pick Warren Buffett’s valuable offering. Buffett cannot make you or me a Warren Buffett. By contrast, John Bogle can help make any of us a canny investor who minimizes wasteful turnover and unuseful selling loads. The only thing better than Bogle’s original book is its improved revision. Bon appetit!”
—Paul A. Samuelson, Nobel Laureate, Economics; Massachusetts Institute of Technology Professor, Emeritus; Professor of Economics, Emeritus; Gordon Y. Billard Fellow
“Were I allowed to recommend only one investment volume to friends and family, the updated edition of Common Sense on Mutual Funds would be it; in no other single place can you so easily, and enjoyably, acquire the expertise and perspective necessary to harness the vast power of the financial markets. This is the book that the investment industry doesn’t want you to read, and is even better than the first edition was 10 years ago. Read it, and your heirs will thank you.”
—William J. Bernstein, author of The Investor’s Manifesto, A Splendid Exchange, The Birth of Plenty, and The Four Pillars of Investing
“How do you improve upon perfection? Well, with this tenth anniversary edition of Common Sense, the best mutual fund primer just got better. Jack Bogle’s work clearly stands the test of time. Bogle’s reflections and additions further underscore his timeless insights. This book remains required reading for everyone interested in funds.”
—Don Phillips, Managing Director, Morningstar
“In this timely update of Common Sense, John Bogle improves on what was the finest book on mutual funds ever written. This new edition addresses post-meltdown investing and helps you make your way through the zoo of financial products offered today. Bogle is one of the few to stick up for the average investor all the time. His watchwords—‘simple’ and ‘low-cost’—are the most sophisticated approach to investing you’ll ever find.”
—Jane Bryant Quinn, financial columnist and author of Smart and Simple Financial Strategies for Busy People
“Jack Bogle cares passionately about everyday Americans—and that passion is palpable in these pages. This new edition of Common Sense won’t just arm you with the investment knowledge you need. It will also inspire you to be a better investor and send you marching into the financial markets with a sense of mission.”
—Jonathan Clements, author, The Little Book of Main Street Money
“In this latest update of his Common Sense classic, Bogle gives us a mother lode of new research and novel insights, which he then combines with wisdom from an amazing array of sources—including the late, great Peter L. Bernstein, the medieval scholar William of Occam, the ancient Hebrew Talmud, and others—to forge a powerful no-nonsense prescription for how individual investors should structure their portfolios in the current market environment.”
—Martin Leibowitz, Managing Director, Morgan Stanley
“For more than half a century Jack Bogle has provided investment insights and pioneering products that have helped both small and large investors. When the history of modern investment management is written, he will stand out as one of its towering figures.”
—Byron R. Wien, Vice Chairman, Blackstone Advisory Services
“Once again, Jack Bogle has delivered straight talk to investors, just when they need it most. This updated edition—complete with confessional mea culpas when called for—shows why Bogle is not only the conscience of the mutual fund business, but its poet and prophet.”
—Tyler Mathisen, Managing Editor, CNBC Business News
Copyright © 2010 by John C. Bogle. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978)750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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Library of Congress Cataloging-in-Publication Data:
Bogle, John C.
Common sense on mutual funds / John C. Bogle.—Fully updated 10th anniversary ed.
p. cm.
Includes bibliographical references and index.
eISBN : 978-0-470-59748-4
1. Mutual funds. 2. Investments. I. Title.
HG4530.B633 2010
332.63’27—dc22 2009037064
Dedicated to Walter L. Morgan1898-1998Founder of Wellington Fund, dean of the mutual fund industry,fellow Princetonian, mentor, friend.He gave me my first break.He remained loyal through thick and thin.He gives me strength to carry on.
Foreword for the 10th Anniversary Edition
Jack Bogle deserves the profound gratitude of the American public. First, he devotes enormous amounts of time and energy to showing investors how to navigate the treacherous marketplace for financial services. Second, he created Vanguard, a rare financial institution that places the interests of the investor front and center. Without Jack Bogle’s efforts, Americans would face a financial landscape nearly barren of attractive alternatives.
Bogle offers disarmingly simple advice: employ low-cost index funds in a low-turnover, disciplined portfolio strategy. Unfortunately, few follow his sensible advice. The vast majority of investors play an active management game in which they lose two ways. First, they lose by choosing actively managed mutual funds that almost always fail to deliver on the promise of market-beating results. The shortfall comes from wildly excessive, ultimately counterproductive trading (with the attendant market impact and commissions) and from unreasonable management fees (that far exceed the managers ’ value added, if any). And, as Bogle points out, nearly all mutual fund managers behave as if taxes do not matter, thereby imposing an unnecessary and expensive tax burden (that often blindsides the investing public when they deal with the IRS on April 15).
Second, investors lose by trading mutual funds with eyes fixed unwaveringly on the rearview mirror. By dumping yesterday’s faded idol and chasing today’s hot prospect, mutual fund investors systematically sell low and buy high (which is a poor approach to making money). Moreover, the frenzied switching of funds often triggers a further tax burden. If investors followed Bogle’s advice to use index funds, by dint of low costs they would beat the vast majority of fund managers. If investors followed Bogle’s advice to take a steady approach to allocating assets, by avoiding perverse timing moves they would benefit from realizing nearly all that the markets have to offer.
Of course, as a financial professional I have my own views and offer two small amendments to Bogle’s recipe for investment success. I would place a greater emphasis on the value of international diversification, particularly with respect to exposure to emerging markets. Second, I would limit holdings of bonds to full-faith-and-credit issues of the United States government. The experience of investors in the recent financial crisis (as well as the experience of investors in the market dislocations in 1998 and 1987) illustrates in high relief why exposure to credit risk (and optionality) undermines the very reason for holding bonds in the first place. That said, Jack Bogle gets the essential elements right. Follow his advice.
Bogle’s sage advice deserves far more attention than it receives. Individual investors must educate themselves to have any hope of executing a successful investment program. Regardless of the approach that investors pursue, reading provides the essential underpinnings for an investor’s education. Jack Bogle belongs to a small group of thoughtful author-practitioners, including Burton Malkiel and Charles Ellis (dare I include myself?), who articulate a reasoned, thoughtful approach to investment. After reading Common Sense on Mutual Funds, move on to Malkiel’s A Random Walk Down Wall Street, Ellis’s Winning the Loser’s Game, and my own Unconventional Success. This handful of books competes with the marketing hype of the mutual fund industry, the blathering blandishments of the brokerage community, and the enervating cacophony of television’s talking heads. (Even after being eviscerated by Jon Stewart on The Daily Show, Jim Cramer continues unashamedly to offer seriously damaging advice to viewers of Mad Money. Across nearly every dimension of the investment world, Jim Cramer stands opposite Jack Bogle. Ignore Jim Cramer. Pay attention to Jack Bogle!)
Jack Bogle’s accomplishments extend far beyond educating the investing public. His Vanguard offers investors an alternative in a mutual fund industry that overwhelmingly fails investors. As one of only two mutual fund complexes (TIAA-CREF, where I serve on the board, is the other) that operate without a profit motive, Vanguard gives investors a fair shake. Aside from Vanguard and TIAA-CREF, nearly all mutual fund management companies seek to generate profits and purport to serve investors. Unfortunately, when the profit motive comes into conflict with fiduciary responsibility, greed wins and profits triumph. The idea of serving investor interests disappears and the investor loses. As Jack Bogle so convincingly tells us, today’s profit - motivated mutual fund companies pay close attention to marketing, make sure to collect high fees, and provide little in terms of actual investment management. Sensible investors avoid the active management morass, embrace the certainty of indexing, and select an investor-centric fund manager.
In spite of his gloomy message about the fund industry’s structural, operational, and performance failures, Jack Bogle retains an optimistic view of the world. I like to think of myself as a positive person, but I worry about the individual investor’s chances for success. In recent years, the burden of providing for retirement has shifted dramatically from the employer to the employee. This policy shift creates a number of issues. First, individuals do not save enough. Second, not surprisingly, those who save tend to enjoy high incomes. Stunning statistics from the Federal Reserve Board’s Survey of Consumer Finances indicate that 88 percent of the top-income quintile participate in defined contribution plans, in which they hold an average balance of more than $260,000; less than 11 percent of the bottom-income quintile participate in defined contribution plans, in which they hold an average balance of less than $2,000. Are retirement programs only for the rich? Third, rich or poor, investors face a substandard set of choices dominated by for-profit mutual funds. Fourth, investors take those substandard investment vehicles and use them to make consistently flawed timing decisions. The net result, as Jack Bogle points out, is that investors fail to capture a fair share of the rewards of investing in the world’s security markets.
Jack Bogle gave the investing public two magnificent gifts—Vanguard, a rare investment management company that acts in the best interests of the investors, and Common Sense on Mutual Funds, a readily accessible guide on how to manage personal investment portfolios. Take advantage of Jack Bogle’s gifts and pass them on to someone you love.
DAVID F. SWENSEN
Chief Investment Officer, Yale University
Foreword for the Original Edition
Why This Book Is Unique
Jack Bogle has written a book on investing unlike any investment book that I have ever encountered, because he discusses sensitive matters that other authors ignore. I hesitate to speculate on why these topics receive such short shrift elsewhere, but I suspect that other experts have horizons that are more limited than Bogle’s, or they have less concern for their readers’ best interests.
People often forget that Bogle is much more than an investment professional who is deadly serious about how individual investors should manage their hard-earned wealth. He is first and foremost a fabulously successful businessman who has built one of the great mutual fund empires with skill and determination, always driving it in the direction of the vision that inspired him when he launched forth on this adventure many years ago. Readers of this book are therefore treated to a unique and unvarnished exposure of the nature of the mutual fund world and how it affects their pocketbooks.
Despite all the high-minded talk we hear from the corporate spin-masters, conflict of interest between seller and buyer is inherent in our economic system. Jack Bogle’s goal was to build a business whose primary objective was to make money for his customers by minimizing the elements of that conflict of interest, but at the same time to be so successful that it would be able to continue to grow and sustain itself. That has been no easy task. The complexity of the job that Bogle set out for himself, however, has enabled him to look at the competition with a very special kind of eye. One of the loud and clear messages in this book is that he is less than pleased with what that eye sees.
We must look at the investment management industry (yes, it is an industry even more than it is a profession) as a business and within the framework of the economic system as a whole. The investment management business is extraordinarily profitable. As such, it responds to the iron law of capitalism that capital will flow to those areas where the expected return is the highest. Over the past 10 years, the number of mutual funds has increased from 2,710 to 6,870, and the number of investment managers has exploded from 1,260 to 5,810. On the other hand, investment management defies the rest of the iron law of capitalism, which is that the very process by which high returns attract new capital inevitably brings down the rate of return as new competitors strive to take market share away from the old. Joseph Schumpeter, in a famous aphorism, referred to this process as “creative destruction.” It is the essence of why our economic system has been so successful and why, despite its many glaring flaws, it continues to command such wide public acceptance.
Investment management firms never heard of such a thing. The growth in the number of managers far exceeds the rate of growth in the number of customers they serve. Willy-nilly, more and more people enter the field without in any way diminishing the profitability of those who have established themselves. Occasionally a startup will fail to make it or an established firm goofs up in some horrible fashion and disappears from the scene, but the great mass of investment managers go right on earning a return on their own capital that most other industries can only envy.
Bogle’s skill in dispensing uncommon wisdom about how to invest and how to understand the capital markets would be reason enough to read these pages. But the big message in this book is that what happens to the wealth of individual investors cannot be separated from the structure of the industry that manages those assets. Bogle’s insight into what that structure means to the fortunes of the individuals whose welfare concerns him so deeply is what makes this book most rewarding. It is not only fun to read: It has a big payoff as well.
PETER L. BERNSTEINa
Preface to the 10th Anniversary Edition
What a difference a decade can make! And in the first decade of the third millennium—the decade that followed the 1999 publication of the original edition of Common Sense on Mutual Funds—the difference was extraordinary. During the two preceding decades, the U.S. stock market had experienced the highest returns—averaging 17 percent per year—in its two-century history. During the past decade, with major bear markets in 2000-2002 and 2007-2009, stock returns turned negative on balance—minus 1.5 percent per year, one of the two lowest returns recorded for any decade during that two-century span.
Similarly, our economy moved from an era of prosperity that was long and strong to a new era of unknown length, beginning with the sharp recession of 2008-2009—now seemingly coming to a close—followed by a sober recovery in which the “new normal” of real (inflation-adjusted) economic growth will likely look more like 2 percent per year than the “old normal” of 3 percent that characterized our economy over the preceding century.
Those are just a few examples of how our world has changed. Globalization is now taken for granted. War—indeed, wars—have followed peace. Political change has been rife, as Democratic leadership has superseded Republican leadership in our federal government. Borrowing has soared to unprecedented and unsustainable levels. But while our citizens strive to reduce their debt levels, the federal debt is virtually exploding upward, with few signs of diminishment on the horizon.
To one degree or another, all of these recent changes have impacted the mutual fund industry. The returns earned by equity funds have, on average, paralleled those of the stock market, although inevitably falling short. But the stock market momentum of the 1990s carried well into the twenty-first century, and mutual fund assets, having grown from $1 trillion to $5 trillion during that decade, grew to more than $12 trillion by the autumn of 2007, only to tumble to $10 trillion in the aftermath of the stock market crash. Nonetheless, mutual funds continued to attract shareholders; the 50-million-person army of fund investors a decade ago is now 92 million strong.
Times have changed, yes. And the fund industry has become an even more important factor in our nation’s financial, retirement, and economic systems. So it is more imperative than ever that it operates, using the words of the Investment Company Act of 1940, “in the national public interest and the interest of investors.”
With the passage of a decade, 2009 seemed a natural time not only to bring out this updated edition of Common Sense on Mutual Funds, but to evaluate its message. In doing so, I have not altered a single word of the original edition, but have chosen instead to update its voluminous data, and to comment on significant developments that have occurred since then—a retrospective, if you will. The comments are interspersed within each chapter, highlighted in red for ease of identification. I’ve tried my best to be candid in describing occasions when experience confirmed my insights of a decade ago, and when experience failed to do so—in essence, where I was right, and where I was wrong.
I’m delighted to report that my first goal, “to help readers become more successful investors . . . [by] developing a sound investment program through mutual funds” has been confirmed. The principles that I set out in the 1999 edition remain intact—and then some. Yes, intelligent asset allocation—the appropriate balance of your portfolio between stocks and bonds—is key to success. Yes, simplicity rules. Yes, the stock market ultimately reflects the performance of the real economy and of corporate business, and of earnings growth and dividend yields. Yes, the costs of investing matter. (So do taxes.) Yes, passively managed low-cost stock and bond index funds continue to outperform their actively managed peers.
And yes, the returns earned in various investment sectors (including U.S. and international markets) still revert to the mean of the market or below. Yes, returns of individual funds also continue to revert to the market mean, as yesterday’s high-performing funds become tomorrow’s laggards. These simple principles—which I later came to describe as based on “the relentless rules of humble arithmetic”—had to hold. And so they did. After all, “the fundamental things apply as time goes by.”
Alas, my second goal, “to chart a course for change in the mutual fund industry,” failed to materialize. Despite my zeal for such reform—and the powerful evidence that demands it—things have gotten worse. The good side of technology—speed, efficiency, information—has played second fiddle to the bad side—enabling the creation of financial instruments of incredible complexity and risk, for example, and encouraging investors to treat funds as if they were stocks and trade them with alacrity. The dominance of marketing over management remains, as does the triumph of salesmanship over stewardship. Fund directors continue to forget that their job is to serve as fiduciaries for fund investors, and the industry’s governance structure remains stacked against fund investors and in favor of fund managers. So I humbly concede that my hope that “time and reason” (using Thomas Paine’s formulation) would combine to force reform in the fund industry remains unfulfilled.
In sum, while my investment principles have indeed become “sufficiently fashionable to procure them general favor” (again using Paine’s words)—at least among intelligent investors, responsible advisers, and informed academics—my crusade for industry reform has clearly failed to do so. But please believe me when I say that time and reason continue to remain on my side, more than ever in this post-bubble environment, which will inevitably reshape investment thinking over the decades to come.
As my dear friend the late Peter Bernstein perceptively wrote in his Foreword to the 1999 edition, “what happens to the wealth of individual investors cannot be separated from the structure of the industry that manages those assets.” That structure has proved to be deeply flawed, and has subtracted wealth from far too many investors who place their trust in mutual funds. While building the fund industry anew is obviously essential, widespread industry vested interests will make reform a hard conflict to win. So I console myself with Thomas Paine’s words, cited at the close of the preface to the previous edition: “the harder the conflict, the more glorious the triumph.”
JOHN C. BOGLE
Valley Forge, Pennsylvania
October 2009
Preface to the Original Edition
In writing this book, my objective is to accomplish two goals: first, to help readers become more successful investors, and second, to chart a course for change in the mutual fund industry. My first objective is familiar terrain. In Bogle on Mutual Funds, published in 1993, I set forth a commonsense approach to developing a sound investment program through mutual funds. Similarly, this book focuses exclusively on mutual funds, for I believe that a widely diversified portfolio of stocks and bonds is essential to long-term investing. For nearly all investors, the most sensible and efficient way to diversify is through mutual funds. Common Sense on Mutual Funds, however, even as it covers some of the same ideas as my previous book, addresses the significant changes in the investment landscape that have since taken place.
My second objective marks new literary, if not professional, terrain for me. In the past decade, as strong financial markets have made mutual funds the investment of choice for millions of shareholders, the industry has embraced practices that threaten to diminish seriously their chances of successful long-term investing. Amid the mutual fund industry’s disorienting promotional din, identifies these practices and presents simple principles for implementing a sound investment program. These investment principles also form the basis for my call for industry change. If mutual funds are to remain the investment of choice for America’s families, change is imperative.
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