September 1, 2011....................................(post and read comments)
Because Bob Brinker did not host Moneytalk last Sunday (the program was re-runs of old calls), I have a special treat for you.
Because Bob Brinker did not host Moneytalk last Sunday (the program was re-runs of old calls), I have a special treat for you.
David Korn's weekly newsletter includes a summary of Bob Brinker's Moneytalk, and sometimes when the guests are important enough, David will cover those interviews too. This week, he reviewed what he had written about Burton Malkiel, Nassim Nicholas Taleb and John Bogle. I chose investment legend, John Bogle, to share with you. Posted with his permission, David Korn wrote the following:
I did some digging into the 12-years of newsletter writing and found interviews from three Wall Street legends and great investment thinkers: Nassim Nicholas Taleb, Burton Malkiel, and John Bogle. I spent some time this weekend editing the interviews to bring the editorial comments up-to-date.....I think and hope and really believe you will enjoy reading them.
JOHN BOGLE
Bob opened the interview telling John Bogle that even after all these years of Bogle preaching the advantages of index funds, there is still the hype to "beat the market." Bogle agreed and noted that traditional classic index funds like the S&P 500 Index isn't growing proportionate to the growth of other managed funds. Instead, exchange traded funds are the rage which can be traded all day long in real time. Bogle said the people that are going to be making money from the exchange traded funds are the people that benefit from active trading -- the brokers who earn the commissions from the trading.
Bogle discussed a fascinating point from his new book. During the last 25 years, the stock market grew at around 12.5% a year as measured by the S&P 500 Index. During that sane time frame, the average equity mutual fund grew at 10% a year which is 2.5% less. Is that a surprise? It shouldn't be because the average mutual fund manager turns out to be average. Of course, there are winners and losers, but the average fund still underperforms. The primary culprit is that the average cost of owning a managed mutual fund is 1.5%. They are also paying high turnover costs. Mutual fund managers tend to turn over their investment portfolio 100% per year, which means that the average stock is only held for a year which Bogle views as speculation, not investing. Finally, most funds (about 60% of them) charge a load, or sales charge, that averages about 1% a year.
It gets even worse. The average fund is returning 10% a year, but the average investor is only earning 6% a year. Why? Because many individuals put little money when the stocks are way down as in the early 1980s, then they pour their money into funds in the late 1999s, and then they take their money out when the market is down again. Thus, investors can be their own worst enemy. Warren Buffet puts it this way: The two worst enemies of the investor are (1) expenses and (2) emotions. We hurt ourselves by being optimistic when stocks are high and pessimistic when stocks are low. We all think we are above average, and we are not.
Bob asked Bogle to explain the unique set up at Vanguard where the shareholders own the management company. Bogle said most mutual funds are set up the following way. A financial company starts a bunch of mutual funds and negotiates with itself an amount to charge for a fee, such as 1% a year to manage the assets of the fund. They are in business to make sure they make money. In that situation, the fund manager has two duties. One duty is to the shareholder, but the other duty is to the investors in the management company. When Vanguard was founded, they didn't like the idea of serving "two masters." Thus, at Vanguard they created a fund company where the managers, directors and staff of Vanguard are all working for the fund shareholders, not a separately owned company. Vanguard operates at cost. Sure, the officers and staff are well paid, but they are not operating in such a manner to charge a lot more. Bogle said the average mutual fund company charges about 1.25% fees of total assets per year. At Vanguard, that same fee comes out to less than 0.25%. As such, Vanguard saves their investors 1% a year.
Caller: This caller is on the management team to select investments for his company's retirement plan. He said there is a lot of resistance to getting index funds and there is a lot of pressure from a big consulting firm to go with managed funds with the promise of "beating the market." Bogle related a poll of investment managers who were asked how many of them had beaten the S&P 500 in the last 10 years. Of those polled, 85% said they had failed to beat the index during that time frame. The same group was asked how many thought they would beat the S&P 500 in the next 10 years, and 90% said they fully expected to. Bogle called that the triumph of hope over experience!!!
Caller: This caller wanted Bogle's opinion of TIAA-CREF and how it ranked compared to Vanguard. Bogle said he has great respect for TIAA-CREF. Its big equity fund has a slightly higher expense ratios (about 30 basis points) than the Vanguard Index funds which are about half that. However, the TIAA-CREF annuity is the best bargain out there. Vanguard has the second best cost structure and expenses are extremely important when it comes annuities.
(David) EC: Interesting. You have to hand it to Bogle for praising a competitor. Maybe daBrink can take that lesson to heart. :) Bob has recommended the Vanguard annuity in the past, but going forward, perhaps he will also recommend TIAA-CREF given what Bogle said today.
Brinker: Bob asked Bogle to comment on Occam's Razor (also spelled Ockham's razor) in the investment context. Bogle said that refers to the principle attributed to William of Ockham that says when there are multiple solutions to a problem, choose the simplest one. Bogle says index funds are the simplist ways to invest and a lot of good things flow from that simplicity, including low turnover, tax efficiency and dividends flowing to the shareholder.
Bogle pointed out that the typical equity mutual fund consumes 80% of the dividend income. The stock market has a dividend yield of about 1.8%, and the average equity mutual fund takes about 1.5%, leaving a dividend yield of only 0.3%!
Bogle noted that the long term return on stocks in nominal terms has been about 9.5%. That 9% was made up of 5% earnings growth, and 4% dividend yield. Today, however, the dividend yield on stocks is less than 2%. Thus, Bogle thinks you can conclude that returns on stocks will be about 2.5% less going forward. That means instead of getting a 9.5% return on stocks, you will get a 7% rate of return. Then you have to take out 2.5% for inflation, which brings your return down from 7% to 4.5%. This is all before taxes! It is also before the charges these mutual funds charge. Bob said he recommends a 4% withdrawal rate, and believes that Bogle's explanation justifies this position and Bogle agreed.
(David) EC: Wow. Bogle's logic is compelling and disconcerting, but definitely jives with the view of a secular bear market, or at least a period of sub-par returns going forward. Warren Buffet has publicly stated a similar long term projection of returns on stocks. Between Bogle and Buffet, you got two of the giants in the financial industry saying the same thing -- and it is a far different cry than what you hear from many on Wall Street.
Caller: This caller wanted to know how Bogle would invest for a grandchildren's college education. Bogle said what he does for his own grandchildren is put 60% in the Vanguard Total Stock Market Index Fund and 40% in the Vanguard Total Bond Index Fund. Bogle said it is a little conservative, but when you get close to college and the bills come due, you don't want to be too aggressive. Bogle said you can start more aggressively, and then slowly reduce the amount of equities as you get closer to the day for college recognizing that the stock market can go down significantly right around the time college begins.
Bogle emphasized the importance of diversification with largely U.S. index funds with up to 20% international. Bogle says at his age, he has 40% in stocks, 60% in bonds. Bogle said he doesn't like to make quick moves, and is going to slowly move up to a 15% allocation in the international arena.
Bogle discussed his new book, "The Battle for the Soul of Capitalism." Bogle said that capitalism has had a wonderful history of being trusted back to the 19th century and it worked because we had "owners" capitalism. Owners put up the capital and took the risk and got the reward. In the latter part of the 20th century, that system turned upside down and now most of the rewards go to the managers. We now have "managers capitalism" instead of "owners capitalism." We can see evidence of this change in executive compensation, financial engineering and manipulation of corporate earnings. It is also in the mutual fund industry where management companies get far too large a share of the returns.
There has been some improvement of late with the passage of Sarbanes-Oxley, greater board room accountability and the inability now for auditors to be part of management. In the mutual fund area, there is an attempt (which is being bitterly resisted) to make mutual fund boards of directors more responsible to the shareholder. The law states that mutual funds should be formed in the interest of their shareholders, but that has often not been done. We would need an independent chairman of the board, the use of independent consultants, etc. These are little things that can bring the system back to balance.
Bob referred to Bogle's investment classic, "Common Sense on Mutual Funds." Bogle said he has been pleased the books have done well, and the proceeds go to charity. Bogle said that book is designed to present common sense intelligent ideas about investing. Themes like investing for the long term, don't pay a lot of money to your fund manager, not moving your money from one fund to another, not hovering over the rankings of mutual funds, and to own Americn business and hold it foreover. Don't trade, don't do anything. Bogle remarked that he knows that Bob shares at least some of the same investment philosopy.
About 30-years ago, Bogle created the "First Index Investment Trust" which is now known as the Vanguard S&P 500 Fund. People laughed at the idea when he first came out with it. In fact, people referred to it as "Bogle's folly." Today, it is the largest fund in the world.
(David) EC: Bogle and Brinker have both done a great service in educating the public about the importance of watching expenses in your investment portfolio, the benefits of using index funds, and the necessity of diversification. The two individals, however, have different philosopies toward market timing. Of course, Bob is a practitioner of market timing, and even uses the name for his newsletter. Bogle, on the other hand, has this to say about market timers in his book, Common Sense on Mutual Funds,:
"The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody that has done it successfully or consistently. I don't even know anybody who knows anybody who has done it successfully and consistently. Yet market timing appears to be increasingly embraced by mutual fund investors and the professional managers of fund portfolios alike."Bogle said there is a way to think about investing that he likes to share with individuals. Investors tend to pay about 2.5% in expenses, which is an incredible amout of money over an investment lifetime. Think about investing one dollar over your entire investment horizon which is around 65 years. You figure that you work for about 40 years, saving and investing your money, and then live another 20 years after that. If you invest $1 over 65 years without expenses, it grows to about $131, using a compound growth rate of about 8%. That's the magic of compounding. However, if you pay 2.5% in expenses, than your $1 will only grow to about $25! That's what we call the "tyranny of compounding costs." It utterly overwhelms the magic of compounding. After you consider the costs, you realize that instead of you, the managers get the lion's share of the returns.
A caller asked Bogle how the Vanguard Total Stock Market Fund has outperformed other similar funds that also track the market. Bogle said there are two reasons why. First, they charge less expenses overall, so they take less out in terms of returns. Second, in recent years they have been able to manage the changes in the index better than their competitors. The man in charge has been a very good administrator of these funds. By and large, however, its the lower expenses that account for the better performance.
Another caller asked Bogle for his opinion on the long-term prospects of the international markets versus the U.S. stock market, as well as his outlook for the dollar. Bogle said he is a low risk-taker in terms of moving in and out of international markets. Bogle said the first question is whether you even want to have exposure to the international markets. Many investors aren't aware that 25% of the revenue for U.S. companies is derived from international sales. That said, Bogle said he understands the logic of diversifying into the international arena. With respect to the dollar, if you look at the long run, the returns of international markets are not that different compared to the U.S. market. There are cycles where there is outperformance in international markets. Bogle said if you are going to invest internationally, he recommends going with an international index fund and sticking with it for the long term. Vanguard has such a fund.
Bob asked Bogle to explain how the structure of a Vanguard fund works for investors. Bogle said when you buy a typical mutual fund, it is really like a corporate shell that holds a package of stocks and bonds. The chairman of the board is usually chairman of the management company that determines the portfolio. The officers are provided by the managers. In otherwords, the fund is captive of the management company. The rewards are enormous for those managers. For example, the typical equity fund costs 1.5% each year, plus another 1% in hidden costs. Contrast that with Vanguard where the funds are directly owned by the shareholders. Bogle said you should always determine whether the manager's interests are paramount, or whether the individual investor's interests are. Of course, in the case of Vanguard, Bogle said they look after the individual.
A caller asked Bogle about the Vanguard GNMA fund and how interest rates will impact the net asset value. Bogle said that when interest rates go up, bonds go down as a general rule. Over the long term, however, keep in mind that interest rates will fluctuate and in most cases, the returns generated will be entirely a function of the income generated. That is the mathematics of bond investing. The net asset value will fluctuate in the GNMA. The net asset value is not guaranteed, and you shouldn't look at it that way, but you should view it as an investment that provides a steady stream of income over the very long term. If you really want stability of capital, you can't get stability of income. You can go with Treasuries where the capital is guaranteed, but the income provided by treasuries is very low. When you go with a fund like GNMA, the trade off is you get higher yield, but you have to deal with the fluctuations of the net asset value.
A caller asked Bogle about the Vanguard Extended Market Index exchange traded fund and was concerned about the low volume of trades. Bogle said if you are buying it as an investment, you do not need to be concerned. In the exchange traded fund (ETF) arena, there is a lot of trading going on, and Bogle doesn't favor that. Long term success is about investing, not speculating. The ETF is actually a little cheaper than the actual fund (not including brokerage commissions), but Bogle said he has not changed any of his holdings to ETFs.
(David) EC: The caller and Bogle were referring to the Vanguard Vipers (ticker: VTI) which I own in my newsletter portfolio. They track the Total Stock Market Index. I like owning the Vipers because I could sell them (or buy them) in real time. The other benefit they have over the fund, is you can short the Vipers if you wanted to. The caller is correct though in that the volume of Vipers isn't that great, with the average volume of far less than the SPDRs (a/k/a Spiders), which track the S&P 500 (ticker: SPY).
Bob commented about how many shares are traded daily of the Spiders, to which Bogle said this just goes to show you that there are thousands of people shuffling money around each day. Bogle quoted Warren Buffet who said that the two greatest enemies of individual investors are expenses and emotion. Bogle said the Vipers take care of the first one, and its up to the investor not to be pulled into the latest hottest fund, whether it is energy, real estate, or whatever. Its hard to do timing, especially when commissions are involved......Indeed."
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2011
Honey here: If you want complimentary issues of David Korn's Brinker-related newsletter or The Retirement Advisor that he co-edits with Kirk Lindstrom, they are available: here
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