Little Book of Common Sense Investing by John C. Bogle

Intro

• The economy is made of businesses
  • The US GDP has grown by a nominal rate of 6.2% since 1929
  • Annual pretax profits of corporations have grown at 6.3%

“A long habit of not thinking a thing wrong, gives it a superficial appearance of being right, and raises at first a formidable outcry in defense of custom. But the tumult soon subsides. Time makes more converts than reason” - Thomas Paine

Chapter 1 - The GotRocks Family

• Stock returns are so variable, not because of the underlying economics (returns & dividends) but because of the underlying emotions of investors
• For investors as a whole, returns decrease as motion increases

Chapter 2

“Over time, the aggregate gains made by Berkshire shareholders must of neceessity match the business gains of the company.” - Buffett

• The average annual total return of stocks is 9.5%, 9% of that is due to dividends and earning growth

• In the same time period, inflation was 3.2% annually, giving only 6.3% real growth

“It is dangerous…to apply to the future inductive arguments based on past experience, unless one can distinguish the broad reasons why past experience was what it was” - John Maynard Keynes

• i.e. beware of speculative returns

• On average, investment growth (earnings + dividends has only been negative for one 10 year stretch, during the 1930s, although market returns have been negative in the 1930s and the 2000s
• Every 10-year-period of negative speculative return was followed by a period of similar sized positive return

“The stock market is a giant distraction to the business of investing”

Chapter 3

• The S&P 500 is a market-cap-weighted index, meaning that you never need to adjust the amount of each company that you own, it’s done automatically.

“With today’s lower dividend yields, the prospect of lower earnings growth and aggressive market valuations, it would be foolish in the extreme to assume that such a return would recur over the next four decades.” (speaking of S&P 500 growth from 1976 to 2016)

Chapter 4

• Costs associated with actively managed funds can be up to 2-3%
  • Expense ratio
  • Sales charges (sometimes spread over 10 years)
  • Sales loads
  • Portfolio turnover costs (bid-ask spreads, commissions, market impacts)
• To demonstrate - let’s invest $10,000 over 50 years
  • Nominal annual return of 7% grows it to $294,600
  • Cut off 2% and it only gorws to $114,700

“You put up 100% of the capital and assume 100% of the risk. But you earn less than 40% of the potential return”

Chapter 5

• All-in annual costs of actively managed equity funds range from 0.9% of assets in the lowest-cost quartile to 2.3% in the highest-cost quartile.
• The lowest-cost quartile perform the best in every asset class

Chapter 6

• Dividends hvave contributed an annual return of 4.2%
• Over 90 years from 1926, there have been only 3 significant drops
  1. 55% decline during Great Depression
  2. 35% decline in 1938 during Depression’s aftermath
  3. 21% decline during the 2007-2008 financial crisis
• When dividends are low, actively managed funds manage to consume a huge percent of their dividend yield

Chapter 7 - The Grand Illusion

• ⭐ Reported fund-wide returns by actively managed funds are often much different than each individual investor’s returns

  “Money flows into most funds after good performance anad flows out of most funds after ************************performance”

  • Dollar-weighted returns reflect how the investor earns their money depending on when they put it in, but time-weighted returns are fund-wide and investor-agnostic

• Faulty timing is more of a problem with regular equity funds than index funds

  • The average fund investor only earns an actual return of 6.3%, while as 7.8% is what the average fund reports returns as
  • The index fund investor earned an actual return of 8.8%, while 9% is what was advertised
  • This faulty timing can be inflamed by marketing by mutual funds, and greed or optimism.

• Adverse selection - Investors also tend to pour their money into the wrong funds (funds that have perfomed well in the past but reversion to the mean often means that they lose what they have gained)

• Some stats to back it up

  • From 2008-2016, 186/200 of the biggest equity funds had lower returns for individual investors than the fund-wide returns they reported
  • ⭐ Net total of only $18 billion invested in funds in 1990 when stocks were cheap, but $420 billion in 1999 and 2000.
  • ⭐ Only 20% of money had been invested in risky aggressive growth funds in 1990, yet investors poured 95% into those funds during 1999 and early 2000.
    • They then pulled their money out and turned too late to value funds

“Fund investors have been chasing past performance since time immemorial, allowing their emotions—perhaps even their greed-to overwhelm their reason.”

⭐ “The beauty of the index fund, then, lies not only in its low expenses, but in its elimination of all those tempting fund choices that promise so much and deliver so little.”

Chapter 8

“About half of all equity mutual fund shares are held by individual investors in fully taxable investment accounts”

• Turnover rates for different types of funds
  • Average actively-managed equity fund is 39% (or 78% depending how if you look at buying and selling)
    • Not only does this turnover happen but it often tends to happen on short-term capital gains basis, further increasing the taxation
  • Index fund is ~3%
• Taxes for different types of funds
  • Average actively-managed equity fund - effective annual tax of 1.5% per year, or about 15% of total pre-tax return (state and local taxes balloon this even higher)
  • Federal taxes cost taxable investors in index funds about 0.45 percent per year, only about one-third of the 1.5% annual tax burden bore by investors in actively managed funds.
• Giving stocks to heirs on the day of dieing increases the cost basis to the current market value of the stock

Dividend yield = dividend per share / price per share

Chapter 9

• 1974 - 2017, the S&P 500 had an average return of 11.7% with 2.9% of that return (25% of the total) coming from speculative return

• United States longterm GDP growth rate is ~6%. Bogle expects US companies to grow earnings @ 4-5%

• Bonds

  "Fully 95% of the decade-long returns on bonds since 1900 have been explained by the initial yield”

Chapter 10

“Don’t look for the needle, buy the haystack”

“Think about the reality that over 25 years the typical fund will replace its managers three times…Think, too about the odds that a given fund will even exist 25 years hence”

• Fidelity Magellan and Fidelity Contrafund both reverted to the mean after years of outperformance → investor cashflows poured out because of it

Chapter 11 - Reversion to the Mean

• Morningstar ratings are based on a composite of a fund’s record over the past 3, 5, and 10 year periods
  • ⭐ The past 2 years period accounts for 35% of rating when a fund has been in business for 10 years, or 65% when it’s only been in business for 3-5 years
• ⭐ Only 14% of five-star funds in 2004 still held that rating 10 years later

“Under normal circumstances, it takes between 20 and 800 years [of monitoring performance] to statistically prove thata. money manager is skillful, not lucky. To be 95 percent certain that a manager is not just lucky, it can easily take nearly a millenium”

Chapter 12

• Investment advisors are good at advising asset allocation, information on tax consideration, and advice on how much to save vs. how much to spend
• HBR Study - “Average annual return of funds recommended by advisers: 2.9%. For equity funds purchased directly: 6.6%.
• There are benefits to using advisers (peace of mind, forming a sensible portfolio, dealing with complexities and tax implications, etc.), but as a whole, the group is not to be fully trusted

Chapter 13

⭐ “Carefully consider your risk tolerance and the portion of your investments you allocate to equities. Then, stay the course.”

• Index funds can often have different prices (many, even up to one third, have substantial front-end loads that have to be paid out over 5 years)

Chapter 14 - Bond Funds

• Since 1900, annual returns on bonds have averaged 5.3%
• Why would an intelligent investor hold bonds?
  1. During many short periods, bonds have outpaced stocks (42/117 years since 1900) (29/112 five-year periods) (13/103 fifteen-year periods)
  2. Bonds can decrease volatility of a portfolio - discouraging counterproductive behavior and providing a better risk profile as someone ages
  3. Bond yields still exceed dividend yields on stocks
• Most bond funds are outperformed by their appropriately comparable index
• From 2007-2017, the total bond bond market index fund returned 4.41%. As of 2017, it’s yield was only at 2.5%.

Chapter 15 - ETFs

• The first US exchange-traded fund was created in 1993 (Standard & Poor’s Depositary Receipts → SPDRs)
• They make trading index funds that much more liquid
• In terms of dollar volume, every day the Spider was the most widely traded stock in the world
• Bogle is against ETFs because they allow for flurried trading, which eats away at the long-term investment ideas that TIF emphasizes

“You may even enjoy a bit of extra tax efficiency from these broad market ETFs”

…skipped 16, 17…

Chapter 18 - Asset Allocation 1

“Authors of books on investing, are, in a real sense, captives of the eras that they have experienced”

• Bogle has seen 60 consecutive years where the dividend yield on stocks has never exceeded the interest rates on bonds (whereas Benjamin Graham saw the exact opposite)

• Benjamin Graham thought the single most important decision to make as an investor is how much to allocate to stocks and how much to allocate to bonds
  • A 1986 study found that 94% of institutionally managed pension fund’s return differences were accounted for by asset allocations
• Benjamin Graham suggested a 50-50 split as being the starting place for asset allocation
• Two things matter for asset allocation
  1. Your ability to take risky (current & future liabilities)
  2. Your willingness to take risk (purely a matter of preference)

Two decisions to make

1. Asset allocation percentages?
2. Fixed ratio (using rebalancing) or non-fixed ratio?

Chapter 19 - Asset Allocation 2

• During 25 years, the 60-40 stock-bond fund returned 8% as compared to 9.3% for the S&P 500, with significant downside protections
• Balanced portfolios can provide income from bond interest payments and dividend payments, along with social security upon retirement
• Bogle argues against investing in international stocks
• Target-date funds hold diversified portfolios of stocks and bonds that gradually become more conservative as the target date is reached
• ⭐ People often don’t consider their social security allocations when considering how conservative there investments currently are - that should be considered a part of the bonds segment
• A rule of thumb is that withdrawing 4% annually will allow your retirement funds to be sustainable