Common Sense Investing: 14 Tips from Jack Bogle for Financial Success
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Introduction to Jack Bogle's Investment Philosophy
In today’s post, we explore 14 crucial insights from Jack Bogle’s ‘The Little Book of Common Sense Investing’ to boost your financial success. This essential guide is perfect for anyone seeking financial success through effective and smart investment strategies. Jack Bogle, founder of The Vanguard Group, transformed the investment world by introducing the very first index fund, a game-changer for investors. He democratized low-cost investing, advocating for long-term, passive investment strategies that benefit individual retail investors.
In this post, we guide you on the best places to invest your hard-earned savings and where to avoid potential financial pitfalls. Until now, our personal finance blog series has covered topics such as the importance of budgeting, financial habits, saving tips, or on tracking and optimizing your savings rate to accelerate financial independence.
Jack Bogle’s core message is clear: prioritize building a diversified investment portfolio with low-cost index funds for long-term growth. Bogle advises investors to consistently buy and hold a well-balanced portfolio of index funds, including both stocks and bonds. This investment strategy promises superior returns and helps secure the best possible retirement. Bogle emphasizes the benefits of long-term investing over risky short-term speculation for achieving financial success. He stresses the importance of minimizing costs and maintaining a diversified investment portfolio for consistent returns.
14 Essential Lessons for Smart Investing from Jack Bogle’s 'The Little Book of Common Sense Investing'
1. Successful investing is simple but not easy
Historical data reveals that owning the nation’s publicly held businesses through low-cost index funds is the best investment strategy, capturing nearly the entire return businesses generate through dividends and earnings growth. An index fund, which mimics the overall performance of the US stock market, allows investors to eliminate the risks of picking individual stocks, focusing on a particular sector, and selecting the wrong manager. Although simple, this strategy faces competition from the investment industry, where marketers push high-fee products.
2. How stock market growth mirrors corporate profit over the long term
While it fluctuates significantly in the short term reflecting week-to-week developments and market sentiment, the long-term correlation between companies' investment returns (dividends and earnings growth) and total market returns (including speculative returns) is nearly perfect (0.98).
Despite the volatility, i.e., short term ups and downs, buying an index fund capture your fair share of the economy's growth through company profits. Remember that, over time, shareholders' aggregate gains must align with the business gains of the companies.
3. Understanding Reversion to the Mean (RTM) in Stock Market Investing
Due to emotional investing, stock market returns can sometimes become excessively inflated. Consider the dot-com bubble of the early 2000s or today's popular stocks with very high PE ratios—prices significantly disconnected from their fundamental value. RTM suggests that, like gravity, overvalued companies will eventually return to a more realistic valuation. The message is clear: in the long run, stock returns depend on the actual investment returns generated by the underlying companies. According to a 2014 Wall Street Journal survey, only 14% of five-star Morningstar-rated funds in 2004 maintened that rating a decade later. Past performance is a poor predictor of future results.
4. After accounting for costs, trying to outperform the market is a losing strategy
Bogle highlights that actively picking individual stocks or timing the market usually leads to lower returns for investors. Bogle believed that costs like high fees and frequent trading often outweigh any potential gains when trying to beat the market. Instead, he advocated for a passive investment strategy, such as investing in index funds, which aim to match the overall performance of the market rather than outperform it. This approach relies on the belief that long-term market growth is more predictable and sustainable than the unpredictable costs of active management.
5. Eliminate all intermediaries to secure your rightful share of returns
Warren Buffett adds a 'fourth law' to Newton's three laws of thermodynamics: for investors collectively, returns decrease as motion increases. This implies that higher investment activity leads to increased costs from financial intermediation and taxes, thereby reducing net returns for shareholders. Jack Bogle highlighted the critical conflict of interest between investment professionals and everyday investors, emphasizing the importance of eliminating intermediaries to maximize your investment returns.
We should view brokers, fund managers, and consultants as professionals who are out there to get a piece of our pie. After financial intermediation costs and taxes, it is incredibly difficult for actively-managed funds to beat an index fund. From 2001 to 2016, 90% of actively managed funds failed to outperform their benchmark indexes, according to the SPIVA report. The S&P500 outpaced 97% of actively managed large-cap funds. This begs the question: why would anyone choose to invest in an actively-managed funds instead of chosing a simple index fund?
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6. The choice between the S&P500 or a Total Market Index fund is easy
In the U.S., the S&P500 index covers the top 500 companies by market cap, whereas the Total Market Index fund offers broader exposure, including 3,000+ additional stocks, representing around 15% of its total value. Over the 1926-2016 period, the S&P500 and Total Stock Market Index presented had a 0.99 correlation, with annual returns of 10% and 9.8% respectively. Both index funds are nearly indistiguishable, and therefore, there is no need to sweat over this one: either one will be a good choice to cover the US market.
7. The evidence of underperformance among actively-managed funds is compelling
The SPIVA report provides compelling evidence on the underperformance of actively managed mutual funds compared to relevant market indexes, reinforcing the benefits of passive investing. From 2001 to 2016, it found that 90% of actively managed mutual funds failed to outperform their benchmark indexes. Specifically, the S&P500 outpaced 97% of actively managed large-cap funds. This begs the question: why would anyone choose to invest in actively-managed funds?
8. Learn how compounding costs affect investment returns
For investors holding individual stocks, Bogle estimates average costs of around 1.5% per year. In actively-managed mutual funds, management fees and operating expenses total about 1.3% per year. However, factoring in sales charges, loads, and the hidden costs of portfolio turnover, the total cost of owning equity funds can reach as high as 2-3% annually. It's clear why outperforming a low-cost index fund, with expense ratios as low as 0.04-0.10%, is so difficult for actively managed funds.
Consider the example below, illustrating the growth of $10,000 invested over 50 years, assuming a 7% market return versus a 5% return after subtracting 2% in costs. Notice that after 50 years, a 2% difference in returns results in over $160,000 less in total returns. Investors should prioritize expense ratios when selecting funds.
Figure 1. The tyranny of compounding costs. Reproduced from The Little Book of Common Sense Investing (Jack C. Bogle). After 50 years, a 2% difference in returns results in over $160,000 less in total returns. Selecting a fund with low costs matters.
9. Why index funds offer superior tax efficiency for investors
Index funds allow investors to defer the realization of capital gains or potentially avoid them entirely through inheritance. Additionally, index funds are tax efficient due to their low portfolio turnover, minimizing capital gains taxes compared to actively-managed mutual funds. This strategy helps to mitigate capital gains taxes.
10. Don’t look for the needle—buy the haystack instead
An analysis of over 355 equity funds over the 46-year period leading up to 2016 found that almost 80% of these funds had gone out of business. If your actively managed fund disappears, how can you invest for the long term? Only 10 funds (3%) outperformed the market by more than one percentage point per year. These are just terrible odds—again, why take the risk? Instead of searching for a special fund that might beat the market—a strategy with terrible odds—invest in a broad-based index fund for long-term success.
11. Beware of the EFT frenzy
Although Bogle describes them as a wolf in sheeps clothing, he does acknowledge that there is nothing wrong with investing in indexed ETFs that track the broad market (e.g., S&P500 or Total Stock Market), provided they are held without frequent trading. One of the primary concerns with ETFs compared to tradditional index funds is their ease of trading, which can lead to counterproductive investor behavior. The essence of index funds is to buy and hold them indefinitely. Actively trading ETFs transforms an investor into an active trader, incurring additional costs as mentioned earlier.
More importantly, Bogle cautions against the growing ETF frenzy, particularly thematic ETFs that reduce diversification by focusing on niche market segments, increasing risk. This approach mirrors active investing and increases the risk of investing in overvalued sectors, potentially joining the crowd just as a bubble forms, before the inevitable reversion to the mean.
12. Understand the importance of bonds in your portfolio
Incorporating bonds into your portfolio is crucial for mitigating volatility, providing stability during market downturns, and preventing impulsive investment decisions—such as panic selling during market declines. Analogous to stocks, bond indexes consistently outperform actively managed bond mutual funds: from 2001 to 2016, bond indexes surpassed 85% of these funds.
13. Acknowledge the critical role of asset allocation in investing
Asset allocation plays a critical role in investing, explaining 94% of the variability in portfolio returns—a key factor in building a successful investment strategy. And yet, here there is no strong data or scientific method for building an optimal portfolio. It is all down to using common sense—to understanding your personal risk tolerance, which encompasses both your ability and willingness to accept risk.
Younger investors who aim to build wealth through regular investing can afford to take on more risk compared to those who rely on their portfolios for monthly expenses. Bogle recommends an upper allocation of 80% stocks and 20% bonds for aggressive investors, and 25% stocks and 75% bonds for very conservative investors who prioritize stability over potential returns from the stock market. This allocation strategy allows conservative investors to sleep better at night, even if it means potentially sacrificing higher investment gains.
14. Consider the impact of social security in your portfolio
When planning your retirement with a 60/40 stock/bond allocation, consider that Social Security benefits act like bonds, impacting your portfolio’s overall risk profile. For instance, applying a 60/40 allocation to a $1 million retirement portfolio would mean $600,000 in stocks and $400,000 in bonds upon retirement. However, if you expect to receive another, say, $1,200 per month from social security (equivalent to a capitalized value of around $250,000), your portfolio's risk profile may be more conservative than initially perceived. In this scenario, you may unknowingly have a portfolio closer to a 50/50 stock/bond allocation, due to the bond-like stability of your Social Security income.
Enjoyed this post? Don’t miss our explanation of the important ‘crossover point’ for financial independence or flexible withdrawal strategies for financial independence and early retirement.
