[Front Cover of The Little Book of Common Sense Investing]

You are probably not surprised to hear that I liked John Bogle’s message in the latest in The Little Book series (aff link). Mr. Bogle has been preaching the virtues of indexing for more than three decades and founded Vanguard to enable investors to put his message into practise. Many of the arguments that Mr. Bogle makes in the book would be familiar to readers: the drawbacks of investing in mutual funds, the importance of keeping down frictional costs such as fees, commissions, sales charges and taxes, the virtues of index funds etc. In my opinion, the interesting bits in the book are Mr. Bogle’s estimate of future returns and his negative opinion on fundamental indexing and ETFs.

Mr. Bogle warns his readers that future returns from equities are likely to be modest. He points out that stock market returns are driven by investment returns (initial dividend yield plus earnings growth rate) and speculative returns (changes in the market p/e ratio). Today, the US market has a dividend yield of slightly less than 2% and earnings can be expected to grow at the historical rate of 6%. So, investment returns should be in the neighbourhood of 8%. Mr. Bogle guesses that speculative return could be -1% over the next ten years and stocks should return a very modest 7% (even less if you think market p/e is going to fall even further).

Fundamental Indexing is getting a lot of press these days because of its supposed superiority over capitalization-weighted indices. However, Mr. Bogle is sceptical that such claims will hold true in the future because it is not clear why the markets under priced some fundamental factors in the past. More to the point, fundamental indices could revert to mean and under perform in the future.

While Mr. Bogle rightly criticizes ETFs because they encourage excessive trading, I am still a fan of ETFs because Canadian investors do not have the opportunity to invest in Vanguard index mutual funds but can easily buy their ETF equivalents.

I think this book is certainly worth reading and would also make a nice addition to your bookshelf (I am adding it to my list of recommended books). Mutual fund investors should pay special attention to the chapters on the hidden costs of investing in funds. Index investors will feel encouraged to stay the course. A sample chapter is available here.

Related: John Bogle’s blog

This article has 13 comments

  1. I’ll check this one out.

    A pretty good book I’m reading right now is “The Four Pillars of Investment” by Bernstein. Very good read – I may buy a copy.

  2. I’m not sure why ETFs would encourage excessive trading. Is it just because they’re on the stock market? There’s no logic to that. If anything I’d be willing to move out of Vanguard’s no load mutual funds more than ETFs if there because there are no trading costs.

    I greatly respect Bogle and his work, but I think he’s a little jaded on index ETFs because they compete with his mutual funds. Vanguard now has offers ETFs as well, so it’s a bit hypocritical of him to be against ETFs. I think it’s more of a case of Microsoft syndrome where he late to the market in an exploding growth area than any real argument against ETFs.

  3. That’s exactly why Investoid – because the ETFs trade real time you can “play” the S&P500 all day long – or whatever other index/sector group you choose to day trade. You can move in and out of index funds too – but only once a day.

    Personally I think EFTs (and index funds) are a great passive investment instrument and the fact that some people want to use them in a non-passive way is entirely their business and completely irrelevant to the passive investor.

    One question I have is – for the passive investor, what is the difference between owning an index fund or an ETF if the cost is roughly the same? Or is that not usually the case?

  4. Canadian Capitalist

    Mike: Thanks for the “Four Pillars” tip. I’ve just made a request at the public library.

  5. Mike and CC: thanks for the elaboration. I agree with Mike; in terms of a long-term investor’s standpoint though, who cares what other people are doing with ETFs? As long as it trades reasonably close to NAV over time it doesn’t really matter. Let day traders do what they will, as long as it doesn’t materially affect the stock price beyond NAV changes.

  6. I’ve worked (Computer tech support) for over 12 years and John Bogle is my Hero. The man is such a saint, and tells it always like it is, with a smile and a hug for every investor. It was a shame when he was pushed aside by the new administration at age 70. His book is a revolution, hence it’s “Little Red” ness. He always has, and always will look out for us small investors. Find, Buy, Borrow or check out from your library this book. He’s not in it for the money, as he has more than enough. He’s the Warren Buffet of the Mutual Fund industry. A respected sage and father figure. May the Almighty ( Dollar and entities) both bless him.

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  10. “The Four Pillars of Investment” by Bernstein.
    Yes, the best book I’ve ever read about investing.
    I wish I had read it before I started investing and perhaps I would not have lost so much money.

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