After a Wall Street career as a stock picker/analyst, I am often asked what’s the next hot stock. Everyone is looking for the next Amazon, Google or Netflix. They love a good investment story on a $5 stock. I know exactly how they feel.
You see, picking stocks is in my blood. I lived for it. For nearly 25 years I worked on Wall Street researching individual stocks and making buy-sell decisions for institutional investors based on that research. It was my job to find (“pick”) stocks that would make clients money.
That’s why admitting that “picking individual stocks will not beat the market over the long term” goes against every fiber of my being. But it’s true. Unfortunately for my own personal wealth and mental well-being, it took me 25 years to realize and admit what many already knew.
There are no hidden investing secrets, no magical chart patterns, and no overnight riches when it comes to investing and accumulating enough wealth for a comfortable retirement. Rather, building wealth is accomplished in a boring manner -- by diligently saving and consistently investing those savings in a few broad-based index funds and letting the magical powers of compounding work while you concentrate on your career and family.
Bogle and Buffett are Right
Some investors have long known that trying to beat the market by picking a handful individual stocks (out of the thousands of stocks available) is fruitless and a waste of time and fees. John (“Jack”) Bogle started Vanguard in 1975 to promote his new creation – the index fund, which is a portfolio constructed to match or track the performance of a market index such as the S&P 500 with minuscule fees. “Why try to find the needle in the haystack,” he would say, “when you can just buy the haystack?”
Even legendary investor Warren Buffett agrees that trying to outperform the market over a long period is a waste of time. To prove his point, he made a $1 million bet in 2007 with Protégé Partners, a Wall Street advisory firm, that the return of a low-cost S&P 500 index fund would exceed the return of “investment professionals” over a 10-year period. Protégé Partners selected five investment experts, who, in turn, employed many more investment professionals, each of which managed a hedge fund.
Buffett won the bet in 2017. Turns out his S&P 500 index fund rose nearly 126%, equating to an 8.5% compounded annual return over the 10 years. This return easily beat the average 36% total return (3% annually) of Protégé’s five, fund-of-funds hedge funds. Buffett’s winnings went to a local Omaha charity.
The moral of these stories: If the professionals can’t outperform the market by picking individual stocks, why should the average investor waste valuable time even trying? They shouldn’t.
4 Steps to Common Sense Investing
Successful investing doesn’t require sophistication and complexity; all that’s necessary is a healthy dose of common sense. Unfortunately, you’re unlikely to hear this truism from Wall Street’s financial-service firms, at least not publicity. Instead, you’ll hear how complicated investing is, and how their advice, their managers, their research, and their expertise are necessary to help you reach your savings goals.
But the irony is that the cost of their services detracts, dollar-for-dollar, from the investment returns that you’re trying to maximize. Before expenses, all investors as a group will earn a return precisely equal to that of the total stock market. As a group, we’re all average. But after the costs of investing – mutual fund fees, trading commissions, sales loads, taxes, and so on – are deducted, all investors as a group will lag behind the market’s return by the amount of expenses they’ve incurred.
In reality, investing needn’t be complicated at all. Your own common sense can set you on the road to financial success. Here are four simple steps to help you get started:
1. Focus on Costs
Keeping your investment expenses at the bare-bones level is the surest route to above-average performance over time. So, avoid funds with sales loads in favor of no-loads. And seek funds with low operating expenses. If your annual expenses are only .2% in a market that returns 8%, each $1 you invest will grow to more than $20 over 40 years. If you pay 2.5%, each $1 grows to only $8.50.
2. Diversify Broadly
Absolutely no one knows what the stock market is going to do tomorrow, let alone next year. Nor which sector, style, or region will lead and which will lag behind. Given this absolute uncertainty, the most logical strategy is to invest as broadly as possible, and benefit from the compounding dividend yields and long-term earnings growth of US (and global) corporations – the ultimate winner’s game.
3. Allocate Prudently
Your asset allocation – the mix of stocks and bonds you hold – will probably have a greater impact on your portfolio’s long-term performance than any other single factor. There’s risk in being too conservative or too aggressive. A very general rule of thumb is that your bond allocation should equal your age minus 10% (i.e., a 40-year old investor should own approximately 30% bonds, 70% stocks).
4. Stay the Course
Paraphrasing Pascal, most of the harm to investor’s portfolios comes from their inability to sit quietly in a room. Our emotions cause us to plunge into stocks at their euphoric highs, and to bail out as they reach depressing lows – precisely the opposite of what the cool logic of common sense would prescribe.
Simple, Common-Sense Investing
The Vanguard Total Stock Market Index fund and its total bond market cousin represent the purest form of common-sense investing, and the simplest way to implement the above rules. Funded regularly and held for an investment lifetime, their rock-bottom costs and broad diversification will provide you with a fair share of whatever returns our markets are generous enough to offer – a priceless guarantee in an industry with precious few of them.
There may be a better strategy than simply buying and holding these two funds. But I am absolutely certain that the number of strategies that are worse is infinite. Just remember: In investing, simplicity trumps complexity. Trust your own common sense.
The 4 Steps to Common Sense Investing portion of this article was written by John Bogle in 2007 and published by The Wall Street Journal in 2019.