PHILADELPHIA — For all the books, articles and TV shows devoted to investing, it seems to be a difficult body of knowledge to master.
But what if the best investing advice is actually the simplest?
That’s the bet being made by a group of rabid do-it-yourself investors called the Bogleheads who are devotees of Jack Bogle, founder of investment management firm Vanguard. Bogle is famous for promoting a low-cost investing philosophy that shuns actively managing assets to try to outperform the market and instead promotes passively investing so one’s portfolio rises along with the market.
This decidedly un-sexy investing advice might have died out if it weren’t for the data proving that this strategy can greatly improve one’s returns. (More on that below.) In fact, this 31,500-member group, originally formed in 1998 on Morningstar.com as the Vanguard Diehards, is thriving: For every member, there are six guests who read but never post, giving it a reach of almost 200,000, and it attracts 16.5 million page views a month. In 2007, the forum moved to its own site, Bogleheads.org, which has seen 1.8 million posts since. It has 55 chapters across the country, plus members worldwide.
Jack Bogle speaking on the first day of Bogleheads 12 (Greg Jones)
In mid-October, more than 200 Bogleheads gathered at the 12th conference to meet their guru himself — who, at 84, seemed chipper despite a scapula injury that had his arm in a sling — and also to talk about how best to invest their assets to accumulate wealth, how best to spend one’s nest egg in retirement and how to invest during retirement (hint: it’s not what you think).
1. Live below your means.
This doesn’t just mean staying out of debt, but also cutting costs so you can save for both short- and long-term goals, from big expenses to retirement. “If you don’t do that, the rest of the stuff doesn’t matter because you don’t have money to invest,” said Mel Lindauer, one of the moderators of the forum. (To get a sense of what you can do if you live radically below your means and save, read about how this couple retired at age 30.)
2. Cost matters.
When we approach our investments, people tend to focus on their returns. But, as Bogle said on the second day of the conference, “cost is the only thing that matters.”
The effect that costs have on performance can be neatly summed up in the below chart, showing that lower cost funds (in red) beat higher-cost funds (in tan) no matter what asset class they covered:
So, when assessing any particular fund, instead of being distracted by the colorful line graph showing its returns from the last few years or the number of stars it got on its Morningstar page, look at these admittedly drier items:
- The fund’s expense ratio: essentially, its operating costs, such as the fee paid to the manager, taxes, legal expenses, and more
- Turnover: how often a fund’s assets are traded; the higher the turnover, the higher the transaction costs associated with the fund
- The load fee: the charge to the investor when buying or selling shares of a fund.
Ideally, all of these factors should be low or below average.
3. Buy the market/diversify.
But actually scratch that last bit of advice, because if cost matters, then the only funds you should be looking at are index funds.
Buying the market has two benefits: First, it naturally diversifies your holdings, hedging your risk.
Second, you’ll do better than most other investors after subtracting the fees other investors pay in actively managed funds.
“Why pay people to do what you can do yourself?” Bogle said, adding that if there’s a 50/50 chance of picking a good manager when trying to select one mutual fund, then if you attempt to pick two mutual funds, your odds that both will be good go down to one in four, and if you want to choose three good mutual funds, your probability drops to one in eight, with four mutual funds, the likelihood is one in 16, and so on.
While some investors might protest, saying that buying the market will guarantee you only “average” returns, Bogle says after taking fees into account, you’ll end up outperforming others. “It seems awful to say we want to pick average managers and win on cost, but that’s the sure way,” he said.
4. Don’t look at past returns to gauge future performance.
“That’s what a lot of people do — especially new investors,” says Lindauer — and if that’s their first error, their second is that when they look at past returns, they tend to be looking at actively managed funds.
This is the classic “buy high, sell low” mistake. As Vanguard chief investment officer Tim Buckley said, “When equities are going well, people pour money into them. When it crashes they get out…. People are still chasing performance.” (Lindauer joked, “Investing is one of the few places where people don’t like to buy things when they’re on sale.”)
Buying high and selling low leads investors to perform even more poorly than their investments. Lindauer said, “Investors underperform the very funds they invest in — because they buy when it’s hot and then sell when it crashes. Say a fund returns 8% — the investors might get only 6%.”
5. Never try to time the market.
“People try to time the low spot and the high spot. They’re in and out. If you’re going to bail, you’ve got to be right twice, because now you need to know when to get back in,” said Lindauer. “People bail out and then they wonder when’s a good time to get back in, and they wait and wait and wait, and watch the market go back up, up and up, and then say, ‘Okay, now it’s safe to get back in’ — just about the time it peaks.”
So not only should you buy the market, but you should also stay in it. Over the long run, the market tends to go up, even if along the way, small dips do occur.
“Don’t try to time the market — it’s time in the market that counts, not timing the market,” said Lindauer.
6. Stick to your goals.
Just as you shouldn’t let drops in the market rattle you, don’t let other news do so either.
“The debt ceiling crisis — not sure how that would change your goals,” said Buckley. “If you had a kid or if your kid graduated from college, that is a reason to change your goals, not what Congress is doing.”
7. Save as much as you can, as early as you can.
Saving early allows you to take advantage of the power of compounding. If Person A saves $5,000 a year from age 25 to 40 for a total of $75,000 and then never invests another penny, and Person B invests $5,000 every year from 40 to 65 for a total of $125,000 invested, assuming 5% growth, Person A will end up with more than $400,000 by retirement, while Person B will only have $256,000, simply because Person A started saving earlier, even if she put away less.
8. Look at the big picture.
Often, people fixate on the wrong details. For instance, they’ll focus on the performance of one investment, instead of the overall portfolio. If you’re guilty of this, keep it simple: go with a target-date fund, which is a mutual fund that is a collection of stocks and bonds whose allocation is determined by your projected retirement date.
Investors also can detrimentally obsess over yield. For instance, investors often flock to dividend-paying stocks, but as Colleen Jaconetti, Vanguard senior investment analyst, said, “Dividends sometimes end up bringing in less than bonds because of taxes and changes in the prices of stocks.” For instance, if you spend $100 on a stock, after your $5 dividend, the stock may be worth $95, meaning your final wealth is $100. On the other hand, if a $100 bond pays $3 in coupon interest, your final wealth is $103.
For that reason, Jaconetti said, “Don’t just focus on income return [such as interest or dividends], but also on capital return [the money you originally invested] for total return.”
9. Automate good behaviors.
Don’t rely on yourself to take the time and energy to invest regularly. We all have busy lives. Instead, invest automatically with every paycheck so that you don’t fall victim to laziness or panic and stop buying if stocks are down.
Another thing you should do is rebalance, which means resetting your investments back to your original allocation after you’ve given them some time to grow. For instance, if you started with 80% in stocks and 20% in bonds, but after a year, your stocks comprised 85% of your portfolio, you should sell your equities to get back to 80%. Some companies will automatically rebalance for you, but if yours doesn’t, then set up your own system. Some people rebalance on their birthday; others wait until they’re five or 10 percentage points off from their initial allocation.
10. Minimize taxes.
Various investment accounts offer different tax benefits. For instance, a Roth Individual Retirement Arrangement levies taxes on your contributions now but allows your investments to grow tax-free. Employer-sponsored accounts like 401(k)s and 403(b)s allow you to defer taxes now, though you’ll have to pay Uncle Sam when you withdraw the money during retirement. Some people have additional investment accounts since retirement accounts limit annual contributions, but these accounts are taxable.
When you think about where to invest, Lindauer said, “Put your tax-inefficient things like bonds and anything that pays out a lot of distributions in your tax-deferred account — you want them working for you over 20-30 years. If you put them in your taxable account, you’re giving the IRS 20% or 30% every year.” Tax-efficient investments, on the other hand, should go in your taxable account.