Index investing: “Confidence in the mathematics”

One central difficulty of investing, both in the U.S. and internationally, is that most individual investors are not sufficiently well-informed on financial matters (or else are not sufficiently disciplined in their approach), and thus often make less-than-optimal choices in managing their long-term savings. The 2014 DALBAR report, for instance, concluded that over the past 20 years, individual U.S. stock fund investors achieved only a 5.02% average annual return, which is considerably less than the 9.22% they could have achieved simply by investing in a S&P500 index fund. Results for other asset classes are similar.

In fact, analyst Richard Bernstein has shown that over the 20-year period ending 31 Dec 2013, the average U.S. investor’s portfolio performance lagged virtually every asset class, from U.S. Treasury bills and corporate bonds to the S&P500 index and Real Estate Investment Trusts. In other words, a simple buy-and-hold strategy with virtually any investment vehicle would have done better than the average investor’s performance, and a buy-and-hold index fund would have vastly out-performed the average investor.

In an interview with MarketWatch’s Chuck Jaffe published 3 Nov 2014, Jack Bogle, founder of Vanguard, a leading vendor of index funds and exchange-traded index funds (index ETFs), had some blunt advice to investors, pleading that “Confidence in the mathematics — the relentless rules of humble arithmetic — enables you to get through.” Here are some excerpts:

On market behavior:

As I have said before, the daily machinations of the stock market are like a tale told by an idiot, full of sound and fury, signifying nothing. … One of my favorite rules is ‘Don’t peek.’ Don’t let all the noise drown out your common sense and your wisdom. Just try not to pay that much attention, because it will have no effect whatsoever, categorically, on your lifetime investment returns.

On speculative returns versus solid earnings growth:

If you go back and look at the history of American business over the last century, you will find the [price/earnings] effect of stocks is zero. All of the returns are created as investment returns, dividend yields and earnings growth, and p/e effect — the speculative return — goes up and goes down and goes up and down for 100 years and ends up just where it started. … So try to ignore these machinations and stick with getting the underlying returns that provide stocks as good investments.

On exchange-traded index funds (for which Bogle’s Vanguard is the world’s largest purveyor!) versus ordinary index funds:

They’re fine just so long as you don’t trade them. … It’s the ability to trade that distinguishes them [from a traditional index fund], and then there is the kind of Looney Tune section of the ETF market pursuing things that no investor should ever do. … Anybody who plays that kind of game [using leveraged or niche products] is a damned fool. … The ETF is the greatest marketing innovation of the 21st century so far. Whether it’s the greatest investment innovation of the 21st century so far, I can’t imagine. I think it’s counter-productive.

See also our earlier blog on exchanged-traded index funds.

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