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Jun 2, 2021

Good Reads In Investing

by Ellen Roseman
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Ellen RosemanCan you keep up with the pros? There’s a continuing debate about whether individual investors can match the returns of professional investors.

It’s hard to pick winners consistently, the naysayers argue. Amateurs lack the time and skill to analyze financial statements and reports to find undervalued stocks with growth potential. Moreover, DIY investors often lose their cool and try to time the market, buying on margin when markets rise and selling in a panic when markets fall.

You’ll have more success and less stress by pooling your money with others and letting the professionals manage your investments, said John C. Bogle, founder of The Vanguard Group, the largest provider of mutual funds and the second-largest provider of Exchange-Traded Funds (ETFs) in the world after BlackRock’s iShares.

Not just any professionally managed fund will do. Jack Bogle is known as the patron saint of low-cost investing after creating the first index fund almost 50 years ago. He got the idea from Nobel Prize-winning economist Paul Samuelson, author of a bestselling economics textbook first published in 1948 and still used in university courses.

Samuelson came up with the “efficient market hypothesis,” which suggests that all the predictable movements of stocks have already happened. When lots of people buy a share that’s an obvious bargain, this causes the price to rise so that it won’t be a bargain any more.

He looked at the data and found most pros didn’t beat the market in the long run—and while some did, good performance often didn’t last. There’s a lot of luck involved, and it’s hard to distinguish that luck from skill.

In a challenge, Samuelson urged someone to set up an index fund, a way for ordinary people to invest in the stock market as a whole, “without paying a fortune in fees for fancy professional fund managers to try, and fail, to be clever.”

Bogle launched the First Index Investment Trust in 1976. It was a flop at first. Investors weren’t interested in a fund that was guaranteed to be mediocre. Financial professionals hated the idea—some even called it un-American. Bogle was effectively saying: “Don’t pay these guys to pick stocks, because they can’t do better than random chance. Neither can I, but at least I charge less.”

People called Vanguard’s index fund Bogle’s Folly. But he kept the faith, and the idea started to catch on. His index funds grew slowly, each one passively tracking a broad financial benchmark, each one tapping into Samuelson’s insight that if the market was working well, you might as well sit back and go with the flow.

In 1995, when Samuelson was 90 years old (he died in 1999 at age 94), he gave Bogle the credit for inventing index funds in a speech: “I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese: a mutual fund that never made Bogle rich, but elevated the long-term returns of the mutual fund owners – something new under the sun.”

Bogle is no longer with us (he died in 2019 at age 89), but you can track his legacy at the Bogleheads Investing Forum, an active online resource for investing questions and answers. There’s a Canadian group too, Financial Wisdom Forum (FWF), which has discussions and hosts an online encyclopedia, Finiki, based on knowledge built up in the FWF discussions and displayed in an easy to search format.

Over his lifetime, Bogle wrote a dozen books, selling over 1.1 million copies worldwide. According to Investopedia, an editor who worked with him told a Philadelphia newspaper, “I don’t think there’s an author who spent greater care on the words he chose. When he did a book, he was so meticulous; he’d rewrite and rewrite. He always went the extra mile to ensure there wasn’t a single person who could not understand what he was saying.”

One of my favourites is Enough. True Measures of Money, Business, and Life, published in 2008 during the U.S. subprime mortgage crisis that set off a global stock market collapse. Still relevant in 2021, Bogle warned of a financial system’s hidden costs driven primarily by speculation and complexity.

“It’s hard to imagine a better time to publish a book that advocates moderation, balance and integrity in the business world,” said a TIME magazine review. “In this wise meditation, Bogle… deplores ‘our worship of wealth and the growing corruption of our professional ethics but ultimately the subversion of our character and values.’ Directly in his sights: CEOs and hedge-fund managers who draw ‘obscene’ compensation. At this time of plunging portfolios, it is a relief to be told that ‘enough’ is within reach.”

In 2007, Bogle came out with another classic, The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. Publisher John Wiley & Sons put out a 10th-anniversary edition in 2017 with two new chapters on asset allocation and retirement investing.

Bogle has a clear message he repeats throughout the book, along with quotations from dozens of experts who support his views. Some readers find this tiresome. “I was convinced fairly quickly, so a fair bit of the book felt like a retread, though it was nice to have these important points hammered into my brain,” says a Goodreads review (three stars out of five).

Even hyperactive investors seem to believe in indexing strategies. Here’s what Jim Cramer, money manager and host of CNBC’s Mad Money, said about an earlier book from 1999: “After a lifetime of picking stocks, I have to admit that Bogle’s arguments in favour of the index fund have me thinking of joining him rather than trying to beat him. Bogle’s wisdom and common sense are indispensable… for anyone trying to figure out how to invest in this crazy stock market.”

Here’s the Bogle message, boiled down to a few paragraphs:

  • As investors, all of us as a group earn the stock market’s return. But the costs of playing the investment game reduce the winners’ gains and increase the losses of the losers.
  • Who wins? It’s the men and women in the middle (brokers, money managers, marketers, lawyers, accountants, investment bankers.) Investors invariably fall short after deducting the costs of financial intermediation.
  • The wonderful magic of compounding returns reflected in the long-term productivity of American business is translated into equally wonderful returns in the stock market. But those returns are overwhelmed by the powerful tyranny of compounding the costs of investing.
  • For those who choose to play the game, the odds in favour of the achievement of superior returns are terrible.

“The intelligent investor will minimize to the bare bones the cost of financial intermediation. That’s what common sense tells us. That’s what indexing is all about. And that’s what this book is about,” he writes in the first chapter.

Bogle’s Little Book has stood up well since publication. The audiobook ($18.77) ranks as the #1 bestseller in Mutual Funds Investing at Amazon.ca. The hardcover book ($29.65) is #2. The Kindle edition ($19.99) is #14.

When I read it now, I’m struck by Bogle’s fierce opposition to the Exchange-Traded Fund (ETFs). He believed index funds should be bought and held for the long-term, but the early ETFs—such as the Standard & Poor’s Depositary Receipts (SPDRs)—were marketed to day-traders.

“I can’t help likening the ETF—a cleverly designed financial instrument—to the renowned Purdey shotgun, supposedly the world’s best. It’s great for big-game hunting in Africa. But it’s also excellent for suicide,” he wrote in the 2007 edition. “I suspect that too many ETFs will prove, if not suicidal to their owners in financial terms, at least wealth-depleting.”

I don’t think his pessimism is justified. Many Canadian investors choose all-in-one balanced ETFs or ETF portfolios chosen by robo-advisors to hold for the long term.

There’s another book I’d like to recommend, sponsored by Vanguard and published by Wiley in 2003, four years after John C. Bogle left the firm. It’s based on the responses of 600 seasoned Vanguard clients who filled out a detailed survey about their investment practices.

This book, Wealth of Experience: Real Investors on What Works and What Doesn’t, is written by Andrew S. Clarke, with a foreword by Jack Brennan, then Chairman and CEO of The Vanguard Group. Amazon.ca sells the Kindle edition for $9.99.

Here are some illuminating findings:

  • If you don’t save, you can’t invest. The simple act of regularly setting aside money outweighs the importance of asset allocation, investment selection, tax management and every other element of investing. It also compensates for the inevitable mistakes that investors make. The Vanguard investors made clear that everyone can save more, a claim supported by academic research.
  • Survey respondents reported checking their portfolios frequently—on average, 88 times a year, about every four days. On balance, however, these frequent checks didn’t lead to frequent changes. “I monitored my portfolio monthly, corrected yearly,” said one investor, a routine typical of those surveyed. Only 16 per cent changed their holdings more than once a year.
  • Simplifying and indexing reduce the number of decisions you have to make. The fewer decisions you make, the fewer opportunities emotion has to wreck your plan. Index funds that aim to track the returns of market indexes eliminate the need to make judgments about a particular stock or mutual fund manager.

Keep emotions in check. The financial markets provoke strong emotional responses that can undermine a long-term sensible investment plan. Media commentary and news about the markets can be a major distraction. A small group of these investors—just five per cent—checked their portfolios once a year or less, and a few of these respondents suggested that checking infrequently gives them a healthy perspective on the market’s ups and downs.

For an update of the classic advice by Bogle and The Vanguard Group, I suggest Beat the Bank: The Canadian Guide to Simply Successful Investing by Larry Bates, published in 2018. A retired banker, he dislikes high-cost mutual funds and helps you find how much of your investment return goes to intermediaries with the T-Rex calculator at his site (https://larrybates.ca/t-rex-score/). No need to buy the book to use it.

Ellen Roseman is a journalist, investing for beginners instructor at University of Toronto continuing studies, board chair at FAIR Canada, an investor advocacy group. @ellenroseman on Twitter.