I hope you all had a great holiday weekend. I certainly did.
Part of what I love about having extra leisure time and a long car trip is the ability to catch up on my reading. Right now I’m making my way through John C. Bogle’s Common Sense of Mutual Funds, and I just finished his chapter on Simplicity.
His premise is that even though the world of finance has become more complex than ever, simplicity is the key to financial success. He adds:
“The central task of investing is to realize the highest possible portion of the return earned in the financial asset class in which you invest – recognizing, and accepting, that the portion will be less than 100 percent.”
In other words, Bogle suggests striving to get as close to the full market return of whatever class you invest in (stocks, bonds, real estate, etc.), realizing that you will never get to 100% because of the costs associated with investing.
Bogle claims the ultimate approach to simplicity can come from owning just one balanced market index fund. I repeat – one fund. The portfolio is entirely indexed and currently has about 60% stocks and 40% bonds (a pretty conservative asset allocation). It really can’t get much simpler than that.
He further makes his case by showing that from 1947 to 1997, the balance fund captured “98 percent of the rate of return of the combined stock and bond market.” Compared to a hypothetical no-load, actively managed fund, investing in the index fund resulted in an additional $535,000 over that time frame.
The advantage that these index funds have over their actively managed competitors is lower costs. The average actively managed balanced fund incurred operating and turnover costs of 1.1 percent, while the index fund was just .2 percent. As you can see that .9 percent advantage can really add up.
Bogle updates the advantage to .6 percent for the returns over the past decade and a shorter 15-year time frame. Either way, the results lead to a resounding advantage for the balanced index fund. The index fund captured 97% of the balanced index returns, while the average managed balance fund earned only 76% of the index returns over the same period.
These kinds of statistics speak for themselves and are pretty hard to argue with. Simple, low-cost index funds will help you keep more of your money working for you and over time increase the amount you earn. Simply put, costs matter…a lot.
You don’t have to worry about fiddling with your investments or seeking out the hottest investment tips. You could even invest all your money in one diversified fund and let time and compounding interest do the work for you.
Some people still may not be convinced by this super simple approach. So Bogle offers some rules for picking funds if you don’t want to index. More on that on Friday.