Investment Advice from Jack Bogle
The father of indexing cautions against trusting money management firms, market timing, or underestimating the potential for stock gains
By Roben Farzad
Jack Bogle turns 80 this May. Last summer his body started to reject his 13-year-old transplanted heart, a turn of events that landed him in the hospital four times as the financial world was melting down. Bogle should be in bed. He has every reason to just sit back and reflect on his career as the father of indexing and as the conscience of the individual investor.
But with the stock market not far from a 12-year low—and banks the world over taking ever-larger bailouts—he'd rather spend these delicate days raising hell (much to his wife's consternation). He thinks mutual funds totally blew it by spending untold sums on supposedly deep-digging in-house research only to totally miss the leverage time bomb. This might be a tad more tolerable, he says, if they didn't pass those costs on to customers, who ended up losing even more.
Bogle is pressing Washington for explicit regulation concerning fiduciary responsibilities. Here is some of Bogle's advice for investors in these turbulent times.
The Stock Market
"If you can't afford to lose one more penny," says Bogle, "get out. But, if you're in your 20s to 40s, keep going. These are good values. The stock market has taken an awful lot of this mess into account, and it's hard for me to believe that common equities won't do better than Treasuries from this point on." Bogle thinks that a 7% nominal return—more than twice Treasury bonds—is realizable over the next decade.
Simple Math
Bogle's "relentless rules of humble arithmatic" show the importance of being vigilant about costs. A dollar invested over 50 years at 8% a year compounds to just under $47. But dock just 2% for expense ratios and transaction costs and you're down to $18. Back out another three percentage points for inflation and you're at $4.38—less than a tenth of your potential catch.
On Timing and Chasing the Sector du Jour
"The stock market's day-to-day is actually a distraction to the business of investing," according to Bogle. His point: The past century of data show that American businesses have grown at an annual rate of about 9.5%, with 4.5% from dividend yields and the remaining 5% from earnings growth. The simultaneous aggregate return on bonds averaged 5%. These are the realistic benchmarks to focus on. "It's all simplicity, mathematics, and common sense," he says. In other words, calibrate your expectations to these long-term figures, a discipline that requires you to ignore the pull of solar, B2B, nanotech, or whatever last year's hot sector was.
Sales Ethics and Practice
Caveat emptor for investors: Don't assume your retirement provider or money management firm espouses a standard of honesty, full and fair disclosure, or putting its clients' interests first. The industry is quietly bifurcated into salesmen and professionals. That is why Bogle is urging Washington to enact a federal standard of fiduciary duty to mandate prioritizing clients, avoiding conflicts, and disclosing all fees.
Overextended Treasuries
"Bond prices are already high. Stocks should do 3 or 4 percentage points better than bonds."
Act Your Age
The percentage of your portfolio in bonds should roughly match your age. For example, a 30-year-old investor would be 30% in fixed income—a 75-year-old, 75%.
Where's the End?
This downturn could last 1½ years to 2 years. But the stock market will recover months before a turnaround comes. Don't try to time your entry.
Plan More Wisely: Your Savings Are Likely Inadequate
At the end of 2008, the median 401(k) balance is estimated at just $15,000 per participant. Even if you project this balance for a middle-aged employee with growth over time via presumed higher salaries and investment returns, that figure might rise to some $300,000 at retirement age (if the assumptions are correct). But while that hypothetical accumulation may look substantial, it would be adequate to replace less than 30% of preretirement income—a help, but hardly a panacea. (The target suggested by most analysts is around 70%, including Social Security.)
Contribute More
One reason for today's modest 401(k) accumulations is inadequate participant and corporate contributions made to the plans. Typically the combined contribution comes to less than 10% of compensation, while most experts consider 15% the appropriate target. Over a working lifetime of, say, 40 years, an average employee contributing 15% of salary, receiving periodic raises, and earning a real market return of 5% per year, would accumulate $630,000. An employee contributing 10% would accumulate just $420,000. If those assumptions are realized, this would represent a handsome accumulation, but substantial obstacles—especially the flexibility given to participants to withdraw capital—are likely to preclude their achievement.
Get Out of Your Own Way
There is excessive flexibility in 401(k) plans. Designed to fund retirement income, they are too often used for purposes that subtract directly from that goal. One such subtraction arises from the ability of employees to borrow from their plans, and nearly 20% of participants do exactly that. Even when and if these loans are repaid, investment returns (assuming they are positive over time) would be reduced during the time that the loans are outstanding, a dead-weight loss in the substantial savings that might otherwise have accumulated by retirement. Even worse is the dead-weight loss—in this case, largely permanent—engendered when participants "cash out" their 401(k) plans when they change jobs. The evidence suggests that 60% of all participants in defined-contribution plans—i.e., a 401(k)—who move from one job to another cash out at least a portion of their plan assets, using that money for purposes other than retirement savings. To understand the baleful effect of borrowings and cash-outs, just imagine in what shape our beleaguered Social Security system would find itself if the contributions of workers and their companies were reduced by borrowings and cash-outs flowing into current consumption rather than into future retirement pay. Bogle wants a new, streamlined, and unified retirement savings system to be stripped of so many confusing options. He says it should be replaced with a handful of conservatively calibrated choices that are clear in their risk profiles and the expectations they can satisfy.
Mandatory Allocation?
One reason that 401(k) investors have accumulated such disappointing balances stems from unfortunate decisions in the allocation of assets between stocks and bonds. While virtually all investment experts recommend a large allocation to stocks for young investors and an increasing bond allocation as participants draw closer to retirement, a large segment of 401(k) participants fails to heed that advice.
The Wrong Mix
Nearly 20% of 401(k) investors in their 20s own zero equities in their retirement plan, instead holding outsized allocations of money-market and stable-value funds—options that are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30% of 401(k) investors in their 60s have more than 80% of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30% or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when members of this age group are preparing to draw on them.
The Under-20% Rule
Company stock is another source of unwise asset allocation decisions, as many investors fail to observe the time-honored principle of diversification. In plans that offer company stock as an investment option, the average participant invests more than 20% of his or her account balance in company stock, an unacceptable concentration of risk. If you feel you must, dabble in company stock with not more than a sliver of fun money. You're already overweighted in your exposure to the company's fate by way of employment and income.
The Old College Try
"Mutual funds can make no claim to superiority over the market averages," argued Bogle in his 1951 Princeton senior thesis, The Economic Role of the Investment Company. In other words, good luck beating the indexes. If anything, his prophecy was understated. Of the 355 equity funds in business in 1970, 223 have since gone bust. Of the 132 that survived, only 24 beat the Standard & Poor's 500-stock index and only seven did so by more than (a statistically significant) 1% per year.
It Runs in the Family
"Gentlemen, lower your costs!" urged Philander Banister Armstrong, Bogle's great-grandfather, in an 1868 speech to fellow insurance executives. In 1917, Armstrong published the book A License to Steal: Life Insurance, the Swindle of Swindles: How Our Laws Rob Our Own People of Billions. "He's my spiritual progenitor," says Bogle.
The father of indexing cautions against trusting money management firms, market timing, or underestimating the potential for stock gains
By Roben Farzad
Jack Bogle turns 80 this May. Last summer his body started to reject his 13-year-old transplanted heart, a turn of events that landed him in the hospital four times as the financial world was melting down. Bogle should be in bed. He has every reason to just sit back and reflect on his career as the father of indexing and as the conscience of the individual investor.
But with the stock market not far from a 12-year low—and banks the world over taking ever-larger bailouts—he'd rather spend these delicate days raising hell (much to his wife's consternation). He thinks mutual funds totally blew it by spending untold sums on supposedly deep-digging in-house research only to totally miss the leverage time bomb. This might be a tad more tolerable, he says, if they didn't pass those costs on to customers, who ended up losing even more.
Bogle is pressing Washington for explicit regulation concerning fiduciary responsibilities. Here is some of Bogle's advice for investors in these turbulent times.
The Stock Market
"If you can't afford to lose one more penny," says Bogle, "get out. But, if you're in your 20s to 40s, keep going. These are good values. The stock market has taken an awful lot of this mess into account, and it's hard for me to believe that common equities won't do better than Treasuries from this point on." Bogle thinks that a 7% nominal return—more than twice Treasury bonds—is realizable over the next decade.
Simple Math
Bogle's "relentless rules of humble arithmatic" show the importance of being vigilant about costs. A dollar invested over 50 years at 8% a year compounds to just under $47. But dock just 2% for expense ratios and transaction costs and you're down to $18. Back out another three percentage points for inflation and you're at $4.38—less than a tenth of your potential catch.
On Timing and Chasing the Sector du Jour
"The stock market's day-to-day is actually a distraction to the business of investing," according to Bogle. His point: The past century of data show that American businesses have grown at an annual rate of about 9.5%, with 4.5% from dividend yields and the remaining 5% from earnings growth. The simultaneous aggregate return on bonds averaged 5%. These are the realistic benchmarks to focus on. "It's all simplicity, mathematics, and common sense," he says. In other words, calibrate your expectations to these long-term figures, a discipline that requires you to ignore the pull of solar, B2B, nanotech, or whatever last year's hot sector was.
Sales Ethics and Practice
Caveat emptor for investors: Don't assume your retirement provider or money management firm espouses a standard of honesty, full and fair disclosure, or putting its clients' interests first. The industry is quietly bifurcated into salesmen and professionals. That is why Bogle is urging Washington to enact a federal standard of fiduciary duty to mandate prioritizing clients, avoiding conflicts, and disclosing all fees.
Overextended Treasuries
"Bond prices are already high. Stocks should do 3 or 4 percentage points better than bonds."
Act Your Age
The percentage of your portfolio in bonds should roughly match your age. For example, a 30-year-old investor would be 30% in fixed income—a 75-year-old, 75%.
Where's the End?
This downturn could last 1½ years to 2 years. But the stock market will recover months before a turnaround comes. Don't try to time your entry.
Plan More Wisely: Your Savings Are Likely Inadequate
At the end of 2008, the median 401(k) balance is estimated at just $15,000 per participant. Even if you project this balance for a middle-aged employee with growth over time via presumed higher salaries and investment returns, that figure might rise to some $300,000 at retirement age (if the assumptions are correct). But while that hypothetical accumulation may look substantial, it would be adequate to replace less than 30% of preretirement income—a help, but hardly a panacea. (The target suggested by most analysts is around 70%, including Social Security.)
Contribute More
One reason for today's modest 401(k) accumulations is inadequate participant and corporate contributions made to the plans. Typically the combined contribution comes to less than 10% of compensation, while most experts consider 15% the appropriate target. Over a working lifetime of, say, 40 years, an average employee contributing 15% of salary, receiving periodic raises, and earning a real market return of 5% per year, would accumulate $630,000. An employee contributing 10% would accumulate just $420,000. If those assumptions are realized, this would represent a handsome accumulation, but substantial obstacles—especially the flexibility given to participants to withdraw capital—are likely to preclude their achievement.
Get Out of Your Own Way
There is excessive flexibility in 401(k) plans. Designed to fund retirement income, they are too often used for purposes that subtract directly from that goal. One such subtraction arises from the ability of employees to borrow from their plans, and nearly 20% of participants do exactly that. Even when and if these loans are repaid, investment returns (assuming they are positive over time) would be reduced during the time that the loans are outstanding, a dead-weight loss in the substantial savings that might otherwise have accumulated by retirement. Even worse is the dead-weight loss—in this case, largely permanent—engendered when participants "cash out" their 401(k) plans when they change jobs. The evidence suggests that 60% of all participants in defined-contribution plans—i.e., a 401(k)—who move from one job to another cash out at least a portion of their plan assets, using that money for purposes other than retirement savings. To understand the baleful effect of borrowings and cash-outs, just imagine in what shape our beleaguered Social Security system would find itself if the contributions of workers and their companies were reduced by borrowings and cash-outs flowing into current consumption rather than into future retirement pay. Bogle wants a new, streamlined, and unified retirement savings system to be stripped of so many confusing options. He says it should be replaced with a handful of conservatively calibrated choices that are clear in their risk profiles and the expectations they can satisfy.
Mandatory Allocation?
One reason that 401(k) investors have accumulated such disappointing balances stems from unfortunate decisions in the allocation of assets between stocks and bonds. While virtually all investment experts recommend a large allocation to stocks for young investors and an increasing bond allocation as participants draw closer to retirement, a large segment of 401(k) participants fails to heed that advice.
The Wrong Mix
Nearly 20% of 401(k) investors in their 20s own zero equities in their retirement plan, instead holding outsized allocations of money-market and stable-value funds—options that are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30% of 401(k) investors in their 60s have more than 80% of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30% or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when members of this age group are preparing to draw on them.
The Under-20% Rule
Company stock is another source of unwise asset allocation decisions, as many investors fail to observe the time-honored principle of diversification. In plans that offer company stock as an investment option, the average participant invests more than 20% of his or her account balance in company stock, an unacceptable concentration of risk. If you feel you must, dabble in company stock with not more than a sliver of fun money. You're already overweighted in your exposure to the company's fate by way of employment and income.
The Old College Try
"Mutual funds can make no claim to superiority over the market averages," argued Bogle in his 1951 Princeton senior thesis, The Economic Role of the Investment Company. In other words, good luck beating the indexes. If anything, his prophecy was understated. Of the 355 equity funds in business in 1970, 223 have since gone bust. Of the 132 that survived, only 24 beat the Standard & Poor's 500-stock index and only seven did so by more than (a statistically significant) 1% per year.
It Runs in the Family
"Gentlemen, lower your costs!" urged Philander Banister Armstrong, Bogle's great-grandfather, in an 1868 speech to fellow insurance executives. In 1917, Armstrong published the book A License to Steal: Life Insurance, the Swindle of Swindles: How Our Laws Rob Our Own People of Billions. "He's my spiritual progenitor," says Bogle.
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