Saturday, August 22, 2009

The Little Book of Common Sense Investing: John Bogle

A few days ago, I wrote a post on the Best Investment Books for Beginners. Having written it, I realized that I forgot a book that deserves at least a special mention.

John Bogle is a man who evokes strong emotions from some, particularly in the professional investment management field. Now, if someone made his career out of how foolish my line of activity was, and how full of myself I need to be to even think that I could be successful, I am sure I would be annoyed too. So I can understand the sentiment of professional money managers.

Bogle is, for those not fully familiar, the founder and (now retired) CEO of Vanguard, and the creator of the world's first Index mutual fund. His entire career since 1975 (when he founded Vanguard) is based on the principle that it is extremely difficult for money managers, professional or amateur, to beat broad stock market indexes over the long term. So you can imagine what his books are going to be about.

The Little Book of Common Sense Investing is the sixth of John Bogle's books and was published in 2007. His most influential book is often considered to be his first two - Bogle on Mutual Funds and Common Sense on Mutual Funds. While they are both great books, I consider this latest book to be the best bet for beginner investors.

The story here shouldn't be unfamiliar to anyone who has read Bogle in the past, or has thought about the economics of mutual funds. The short version is this - Professional money managers as a group cannot, almost by definition, earn better returns than the average stock market. On top of that, they have high transaction costs, taxes on realized gains, timing risks, and expense ratios that make it extremely difficult for an actively managed fund to beat a broad index over an extended period. Finally, though it is very difficult to beat the indexes over the long run, it is not impossible. Skill does exist. However, you needs years of performance data before you can be sure that great performance you see in a manager isn't merely statistical chance. And by the time you are relatively sure, you have already missed the big part of their run up! Hence for most investors, Index funds should form the core of portfolio holdings.

While this is a familiar line of Bogle attack on the Mutual Fund industry, there are a few new things in the book that make it useful for beginner investors to consider. There is an updated analysis of mutual fund performance till 2006. Since the first Index fund was launched by Bogle in 1975, the analysis is able to look at about 30 years of data and actually show how, after all the verbal sparring, professional money managers have been able to do against his 'buy everything in sight and stay put' strategy. And the results are compelling! Then there is a little discussion on the different variants of Index mutual funds that have recently come up - sector indexes, style indexes, internal indexes, 'fundamentally weighted' indexes, and most importantly, ETFs. What Bogle says about these variants is well worth listening to.

One nit - I am not entirely sure about Bogle's scepticism about Index ETFs. I think he makes a great point that by their very structure, ETFs encourage trading. And trading is a gory returns-killer. So I can understand the advice for beginner investors to stay out. But for someone who has bought into the philosophy of 'buy and hold', ETFs have the great advantage of saving 10-15 bps in costs. Not to mention the ability to buy on a limit order. Maybe analysis in his next book with talk more about this.

That aside, I think this short book is well worth the few hours it should take you to read. In terms of dollars that a book can make you per page read, The Little Book of Common Sense Investing ranks pretty close to the top of the list!

1 comment:

  1. In terms of dollars earned per page read, this post may be the highest ranked!