Breaking With Bogle
John Bogle’s investing philosophy needs some updating to reflect new findings.
Bloomberg, January 30, 2015
Now before I commit blasphemy, a few words: I am as close to being a Boglehead as you will find, without actually being one. The bulk of my portfolio is in passive indexes. Most of the assets I manage are in a broad allocation model.
This is a tribute to the wisdom and teachings of investing legend John Bogle, who founded Vanguard Group 40 years ago on the premise that matching market-based returns yielded better results for most investors than picking individual stocks, market-timing or any other investment strategy. During the past four decades, the sleepy firm Bogle started has turned into an investment giant, now managing about $3 trillion.
But we have learned many things during the intervening years. I don’t want to commit the sin of ignoring the accumulated quantitative evidence. There are certain mathematical truths in investing, and to pretend they don’t exist would harm my portfolio (and my clients).
Please understand that my deviation from Bogle’s philosophy isn’t due to hubris, but rather, mathematics. Certain facts of long-term investing have such strong evidence behind them that they are almost incontrovertible. It would be irresponsible for any investor, or their fiduciary, to ignore this evidence. Hence, I find myself at odds with someone I respect in four areas of portfolio management:
1) Overseas Investing: Last year, Bogle restated his bias against emerging markets and non-U.S. assets, saying, “I wouldn’t invest outside the U.S.,” primarily because of currency costs.
This approach has numerous problems. It ignores diversification of assets. It ignores equities in other parts of the world that are both cheaper and faster-growing. It ignores that over time, currency issues are a wash. It reflects a home-country bias. As Cullen Roche pointed out, excluding a vast class of assets turns Bogle into “an active investor in passive clothing.”
2) Smart Beta: Bogle recently said this to Institutional Investor: “Smart beta is stupid; there’s no such thing. It’s an idiotic phrase. Quoting Shakespeare, I guess: It’s a tale told by an idiot, full of sound and fury, signifying nothing.”
By smart beta Bogle means moving from market-capitalization-index investing strategies to alternatives. Look, it’s almost an accident of history that the Standard & Poor’s 500 Index was built in a market-capitalization-weighted form. As numerous studies have pointed out — perhaps most famously by Rob Arnott of Research Affiliates — weighting indexes on just about any other fundamental basis not only outperforms market-cap-weighted indexes, they do so with less volatility. It’s an improvement on the original concept.
3) Small-Cap Stock Premium: The small-capitalization stock premium has persisted long enough that we now know it isn’t random. Weighting a portfolio toward smaller-capitalization stocks — especially small-cap value stocks — generates additional returns over time. AQR Capital Management’s Cliff Asness recently summed this up in a post declaring, “The Small-Firm Effect Is Real, and It’s Spectacular.” If you are going to deviate from a pure passive index, then this is the way to do it.
4) Exchange-Traded Funds: Bogle hates them. Investors like their low costs, and the ease with which they can buy or sell them without some of the hassles involved in buying or selling a mutual fund.
People can overtrade ETFs, they can turn the pursuit of smart beta into another dumb alpha-chasing exercise. There could always be a currency loss from overseas investing in any one quarter. But overall, they do more good than harm. Ultimately, any of these four areas can lead to poor investor behavior. However, to adapt an aphorism, finance advances one white paper at a time.
Bogle is in the pantheon of the greats. His contributions to the investing world can’t be overstated. But the world has learned much since John Bogle started Vanguard in 1975. If he stands for anything, it’s having an intelligent investment philosophy based on hard-won wisdom. It would be an unfortunate error to ignore the newest data that logically leads to deviations, however minor, from his original plan.
Originally: Breaking With Bogle
It’s hard to disagree given the framing. I’ll just say this:
1) For a time Bogle said no international, but he’s backed off that and doesn’t mind “some.”
Jack Bogle cites the (difficult to calculate – and FX wavering) percentage of US profits from foreign sources to support his argument. But on the one hand disparate nation’s equities tend to perform closely over long time frames, meaning Cullen Roche’s argument is wrong since global equity returns also tend to even out the way currencies do. Countries have different risk profiles but that is reflected in the price. Capital markets force a uniform return on invested capital via price. (I have a big dose of foreign.)
When the Cullen Roche’s of the word come up with foreign bourse distinctions, they’ll have some reason for those slightly better returns. Ignore that too.
2) Backtested efforts are just that.
However when combined with 3) you are adding more risk with smaller stocks. Big stocks can become small, but in aggregate, no one can pick them ( GE? FB? GM?.) Mega cap indices are cheaper to own, and manage. Since small caps will fail more often, the question is one of price-weighted failure. If the bio-tech boom (we are in the beginning stages of) blows up like the dot coms then large cap risk will show up even greater in future backtesting. If not, than not. (I have small caps in equal weight to large caps.)
I have a belief that large-organization innovation skills may grow. Some people believe strongly that this will never happen. Obviously it is possible that even if it does, it may only be marginal, or regress to the mean in the next generation. But some people trade off star charts Not much difference.
3) Backtesting, again.
By “tilting” your index to small cap you have 2) backtested performance gains because you take more risk. You cannot know in advance how much more risk you have with bigger stocks. Bogle’s main argument here is that to stay the course, you can only out-do by such a small amount that the extra gain may not be repeated, for you. And that the typical investor, with little capital, should simply take advantage of lower fees with TSM (total stock market) indices. The effect is greater with small cap value. (Half of my small cap is small cap value.)
4) Bogle hates them only if you trade them. Trading is irresistible to some, but those percentages are changing; will it be permanent? (I am 100% ETF. I buy and sell only to re-balance back to my asset allocation)
Also, Bonds are another area where it’s hard to index and Jack offers nuanced advice.
All of this may move BR’s way in the future, or Jack Bogles’. Who knows? These differences are not splitting hairs, and BR’s approach may turn out to give you a long term advantage. It’s a bet. The biggest problem is to be certain you do know. That means going with BR – or Jack – will work out much better for you than any alternative.
Re: #1 International – Vanguard currently uses 30% international stocks in their equity component and 20% international bonds in their bond component for their Lifestrategy and Target Date funds. That is a compromise position between Bogle’s typical stance and Cullen Roche’s “Global Asset Portfolio”.
Re: #4 ETFs – Most recommendations to use ETFs come from financial professionals with backgrounds as traders and/or brokers. They live and breath intra-day trading platforms in the markets. The average person does not.
Instead, the average person thinks in terms of dollars, not number of shares, for their total portfolio value and what they need to buy and sell that day. Figuring everything out and then entering the trades with appropriate limits so that shares don’t get dumped at unfavorable pricing is a skill set many people would prefer never to develop.
I have a couple of ETFs in my IRA. However, down the road I can see simplifying the account into mutual funds to make future transactions in old age easier as financial faculties wane and for my wife who doesn’t do any trading as her 403bs are just in Target Date funds.
More regarding the argument for financial simplicity in retirement
http://www.marketwatch.com/story/how-to-protect-elderly-loved-ones-from-financial-ruin-2015-01-28?page=1
Bogle really isn’t part of Vanguard anymore. Has had no hand in decision making for a long time.
I think Bogle’s single biggest contribution has been his relentless focus on simple investing with low fees. Investors who followed his basic advice of a rock bottom expense 50/50 balanced index fund would have outperformed the vast majority of investors over the past 2-3 decades. His curmudgeonly insistence on this has been refreshing in a world where additional complexity is generally used to mask extracting additional fees, often at outrageous levels, with no evidence of actual outperformance.
I agree with all of the points that you make but it takes a lot of work for most investors to understand how to do it and end up with as good or better results than Bogle’s simple approach. People with portfolios that are just sneaking into 6 digits are usually simply going to end up being lunch for the various financial “advisors” that are willing to “help” them. So the average or median investor would generally be better off with a Vanguard balanced, fund, a Lifestrategy fund, or one of their target date funds than the various concoctions of 1%+ fee funds that their “advisors” are signing them up for.
Companies like yours are making the world a better place for investors, as Charles Schwab, T Rowe Price, and Vanguard did before, but you are still a small percentage of the total assets that are controlled by non-fiduciary entities. I saw it when I attended a sign-up session for my wife’s 403b. The very cheap provider who would enroll us in Vanguard funds for only a small mark-up fee was sitting very lonely at a table while the 1% wrap companies investing in 1%+ mutual funds were handing out the pens and other goodies to the long lines in front of them.
Well put. The simplicity of “US, Vanguard Index funds”, probably still beats figuring out which smarter beta index fund to buy, and which overseas area to invest in. It also will better weather events where the semi-novice investor will be tempted to ditch the overseas parts at the worst possible time.
S&P 500 also gets a lot of its profits from overseas.
Plus, once you have been taught to look for low cost, 0.17% Admiral fees (or less)
look a lot cheaper than 0.45% Overseas index funds.
Bogle comes from an era where workers had pensions, stable employment, and growing salaries. One “could” index and come out ahead. Now, the working world’s situations is different. Right at a time when boomer aged workers need higher retirement asset growth trajectories to make up for the “shortfalls” in their plans ( or lack of plans), Vanguard becomes more powerful. So an investor makes 7 – 8% a year and has low fees ( Robo advisors “stated” returns aren’t that great either). So what ? The low fees aren’t going to help much when they are going to need 13%+ returns per annum going forward …
This 8-year chart says Bogle was dead right about avoiding the international scene, on both sides of the bear/bull cycle:
http://stockcharts.com/h-sc/ui?s=VEU:VTI&p=W&yr=8&mn=0&dy=0&id=p88296419728
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ADMIN: Corrections
1. That comes up as a 3 (not 8) year chart.
2. Even 8 years of underperformance is insufficient. How did EM and ex-US Dev nations do in the 2000s? 1990s? 1980s?
Your timeline is way too short.
Corrections to your corrections:
1) It is an 8-year chart, but you’ll need a membership to see more than 3 years of data at StockCharts.com. Sorry. The 8-year performance of VEU and VTI is, of course, widely available from many sources. Note that we’re talking about 40-50% underperformance over those 8 years — not trivial.
2) The burden of proof is not on me. The article claimed Bogle was wrong, but the evidence given in the article is not compelling. The past 8 years support Bogle. Since you invited longer-term comparisons, I’ll add that the longest-running Vanguard international mutual fund, VTMGX (developed markets index) has also underperformed the S&P500 by 25% over the past 15 years (life of fund).
Personally I’d prefer not to invest in an asset class that has underperformed by 40% over 8 years, or by 25% over 15 years, unless I had a value-driven case for owning it now for the next 8 or 15 years.
Oddly enough, a simple intermediate treasury fund (VFITX) beat BOTH the US and international index funds over the same 15-year timeframe, and did so with far lower volatility.
I believe all of this data is on a total return basis, but one should do their own due diligence.
Personally, since all 3 asset classes (US stocks, international stocks, and bonds) are well above historical valuations, they are all due for poor future returns for some time to come. The whole buy-and-hold paradigm worked well for 40 years due to the deep undervaluation and high interest rates in the 1970s, but those days are over. The buy-and-hold approach for individual investors is deeply suspect going forward.
Actually the post implies one should pick a total world stock index fund, or a domestic total market and an international stock index fund. Now the problem there is that if one went back 110 years several international markets essentially got wiped out at least once, germany twice, Russia, Austria, France came close, Italy, Japan… Its easy to find S&P 500 returns back that far, but I tried a bit to find total world stock returns and could not. It seems a good assignment for an intern, that likes to spend time in a library, among old newspapers. The FTSE only goes back to the mid 1980s the Dax to 1970 etc. Some one must have had indexes before WWII outside the US but what were they etc?
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ADMIN: The S&P500 only goes back to 1958. Prior to that some folks substitute an (after the fatc) made composite of the 500 biggest firms.
Check out https://www.globalfinancialdata.com/News/Articles/Ten_Lessons_For_21_Century.doc — 1950 (65 years ago) was a turning point for global investing.
The MCSI goes back to 1969 And here is its Wikipedia Page:http://en.wikipedia.org/wiki/MSCI_World
Taking the returns listed on the page thru 2013 gets an average return of 11.19 versus the result of the s&P 500 from http://www.moneychimp.com/features/market_cagr.htm of 11.52. Both are the averages and not annualized. But it does show how big the the S&P 500 is of the whole world.
I believe the DOW goes back to 1910. It’s imperfect in many ways, but it does track the S&P very well and has a long timeline.
Taking shots at one of my heroes. Just ruined my day. The picture reminds me of the pictures used by those politically motivated to make the other guy look foolish, old, ugly etc. Cheap shot. Also using words like “Exchange-Traded Funds: Bogle hates them…” without any evidence hardly supports your lead that your disagreement is based on hard data or mathematics as you claim.
Your math is my BS.
“I’ve never met a man that knows everything” my saying. That is true for all men including Bogle, Buffet, you etc. Doesn’t mean you aren’t worth listening to. Just means you aren’t always right and neither is Bogle. It might be in your interest to remember this.
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ADMIN: Read the original
http://www.institutionalinvestor.com/article/3421707/asset-management-indexing-and-etfs/active-managers-losing-ground-can-thank-john-bogle.html
As to ETFs, LMGTFY:
http://www.thinkadvisor.com/2012/09/25/how-john-bogle-really-sees-etfs
http://finance.yahoo.com/blogs/breakout/etf-trading-no-way-invest-says-bogle-140924616.html
That was embarrassing … for BR. The picture was a low blow.
Here is precisely how beautiful John Bogle is:
http://www.vanguard.com/bogle_site/lib/sp19981117.html
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ADMIN: You sholdbe aware that the Bloomberg editors select the picture — and the headline — not Mr. Ritholtz. Thats pretty standard in journalism — the writer provides the tex and the publisher/editor does the rest
The longer term data you’re looking for can be obtained in the credit Suisse year book or Barclays equity gilt study – also an annual publication offering extraordinarily deep analysis of market data and macro factors that might drive future directions.
If you own a large cap stock fund with only so called American companies you already own the equivalent of owning foreign stock. Most of those companies are international today and do a large piece of their business over seas. Knowing this might weigh how much of direct foreign stocks you want to own so as to remain diversified.