Notes From a Leader: What I learned From John Bogle’s Common Sense On Mutual Funds

John Bogle, the founder of Vanguard, has written a number of books on investing and has some key points that he shares his book: Common Sense On Mutual Funds. It turns out that it is an oldie but a goodie when it comes to investment advice.

Common Sense dictates that you keep an eye on some key factors when it comes to long term investing. Some of these I’ve already discussed in other key articles so you can click through on the links if you want more information. New topics were introduced, however, so it is worth some explanation here.

Time. Time is critical when it comes to investing; this is due to compound-interest.

Duration. Investment Duration is something that is a new concept for me, at least as John Bogle explains it in this book. Investment duration is a wonderful concept whereby the returns of long-term investment are driven toward the mean (or average) as the duration of investing is extended.

In simple terms, over the shorter term of 1-3 years, the return of a stock mutual fund investment might have a range of +/-25%. But if you extend the duration of that investment into the 3-5 year period, you might find a +15%/-10% return. And if you extend that return out to 5-10 years, it might be something like +12%/-1%. And finally, after 10 or more years, the return is somewhat flat around +10%/+7%.

I don’t want to risk complete plagarism, but Bogle makes a strong case here in his book for understanding the importance of long-term investing. This is because when you extend the duration of your investment, you virtually guarantee yourself a lower-bound return on your investment. In my fake example above, you can see that as you extend the timeframe, the lower bound increases. At the same time, the upper bound also decreases. Both bounds approach the mean (or average) return of the stock market.

Averages are critical to understand because achieving a true average means that you’ve beaten 50% of the investments out there. This is like getting a solid B on a test. I don’t know about you, but if I could get a B without doing any studying, that is what I would do. Investing for the long haul is just like this. You practically guarantee yourself a lower bound return if you extend your active investment over a significant duration.

Cost. Most people don’t consider cost enough when it comes to investing. The reason for this is that they like to think that they are smart and will be able to ‘build a better mouse trap’ when it comes to their portfolio. Pride is expensive though. Bogle details a simple example where the average mutual funds might cost 2% per year. Index funds on the other hand often have expenses of 0.2%. This is a 90% discount and often times, index funds are less risky than managed funds over the long term.

Costs are reduced by index funds because there is less overhead in terms of staff and research. Indexes don’t need to find investments, they simply purchase the market in the appropriate ratios. All they need is some computers and a few accountants. No fancy market analysts, no fancy and expensive fund manager to keep happy, really. Over the long haul, that two percent can make a real difference. See below:

10000 @ 12% for 40 years compounded = 930510
10000 @ 10% for 40 years compounded = 452593

Lets say that you save 2% on costs each year for a 40 year investment. If you start investing at age 25, this is not unreasonable to consider. This is almost a 50% difference in terms of returns. The amount invested makes a significant difference and absolutely must be considered. And that is the long and short of the book, really. Understanding the real impact that these costs have on your investing is what makes a big difference. If you’ve never read anything written by Bogle, I think you’re missing out. Even if you disagree, its worth at least understanding his argument.

You find the book on Amazon here.