John Bogle is on the short list of my investing heroes, which may seem odd considering that he is the father of passive investing and the creation of mainstream index funds, while almost all of my writings focus on purchasing ownership stakes in individual companies.
The factor that we have very different investing styles is irrelevant—John Bogle has made it much easier for middle-class investors with incomes below $100,000 and no investment connections to get started with the wealth-building process, and I heavily suspect that we agree on far more than we disagree.
In particular, there are two areas where Bogle’s advice on index investing flows from the same type of logic that leads me towards blue-chip dividend investing.
Bogle has advocated two particular concepts for most of his adult life as a figure in the finance community.
(1) First, he argues that investors achieve subpar returns because they are constantly paying high fees, often in the ballpark of 1-2%, for a financial advisor or mutual fund company to manage the wealth that you have built up over the course of your lifetime.
It may sound like I’m being a cheapstake complaining about a 1.5% fee, but the innocuously sounding amount of money is crazily detrimental to your net worth because it is a percentage of assets and it gobbles up your wealth for the entirety of your life that you let some other entity manage your money.
Picture someone who goes through life earning 9.5% annually while investing $500 per month for 35 years, paying a 0.00% expense fee. That guy and his wife are going to end up with $1,669,731. As for the guy who has to pay 1.5% for the entirety of his life? He is going to pay $275,961 in fees and only end up with $1,393,770. At first, that sounds insane—how the heck does a 1.5% fee cost you the equivalent of a sweet middle-class home in suburbia over the course of your investing lifetime? But think of it like this: paying someone 1.5% on a $1,669,731 nest egg would give your manager over $25,000 in that year alone—when you add up the other 34 years, you eventually get to over a quarter of a million bucks.
(2) Secondly, John Bogle argues that another reason why investors underform basic stock market indices like the Dow Jones and S&P 500 is because they sell stocks too frequently, buying and selling at inopportune moments rather than truly becoming business owners.
Both John Bogle and myself are in agreement on what the problem is—our difference lies in the solution to the problem.
Bogle’s solution to fund management fees is to buy a low-cost index fund, a service provided admirably well by the firm he founded, The Vanguard Group. Some of the funds have fees around 0.10%. Considering an investment in something like the S&P 500 requires no real time commitment on analysis skills on your part, that’s a damn good deal. A $100,000 portfolio would only have to pay $100 in fees per year, or about $8.33 per month.
Bogle’s strategy works well for a lot of people that want to build wealth in the abstract, but don’t want to put in the time necessary to do the research and monitoring necessary to do it with individual stocks, REITs, MLPs, corporate and international government bonds, etc. Do you think most doctors working 50+ hours per week and having $10,000 per month to invest care about researching the fact that Visa has no debt? For the investor with a limited interest in the dirty time-consuming analysis of finding individual investments, Bogle’s life work has been a godsend.
But I am interested in researching individual companies. I love reading about how Johnson & Johnson goes to extraordinary lengths to shelter their international operations through Irish subsidiaries. I love studying the fact that Dr. Pepper does most of their product by my childhood home in St. Louis and has sold most of its international trademarks to Coca-Cola, and in a few limited cases, to PepsiCo. I love knowing that tobacco investors have made people rich beyond their wildest expectations because no growth is figured into the share price, and when you do grow earnings per share while paying out a big ‘ole dividend, crazy amounts of wealth get created over the long term.
My way of removing fees from my life is to own the underlying companies outright, with no middleman involved claiming rights on my assets—all I have to deal with are the $8.95 fees necessary to purchase the stock in the first place.
Here’s how I would envision it playing out for a guy in his mid 40s with a $250,000 portfolio. If you go the indexing route, you’re going to pay $250 in the first year, then a little bit over $250 in the second year, and so on as the portfolio grows. Over the course of the first four years, you’d be looking at $1,100 or so in total fees.
For someone building their own portfolio of 25 stocks, it’s going to cost about $225 to get the portfolio constructed (roughly on par with the first year costs of the index fund in the first year). From there, the costs will be in the vicinity of $50 per year, as you use the dividends to add three or so positions to your portfolio (they may be in the same stock you already own), and perhaps you sell two stocks each year for whatever reason.
If you a truly a long-term investor and you have six-figure wealth, you might do a little bit better on the fee front than the index investor, but it’s not a huge deal of difference—the important thing is that both strategies avoid allowing others to sap 1.5% or so from your net worth each year.
You don’t want to be the old lady that gets scammed by an investment professional charging 2.5% per year, and then he takes the money and invests it into a “fund of funds” that charges expense ratios of 0.5% for the packing, and an additional 1.0% or so for each fund that gets included in the packaging. That’s fee hell.
The second problem identified by Bogle is that investors trade too much, and that’s probably true. His solution is to own broad based index funds, because it allows you to own all the big players in an economy. When you buy something like the S&P 500, all you have to do is bet that corporate profits among the 500 selected companies will be higher five, ten, fifteen years from now than they are today. That belief is enough to allow some people to be patient with their capital and put their money in an index fund.
My answer to the “don’t trade too much” problem is to think like a long-term business owner. That means not worrying about the prices of assets that you own, and also means focusing on the profits generated instead of being a ping-pong ball that reacts to every downtick and price or bad earnings report. It’s all about focusing on the dividends provided to you by the investment, and absent that, a long-term focus on the true earnings power of the company you own.
To give an example of what I mean by that, I’ll use BP oil as an example. Normally, you’d measure your success with the rising dividend income from the investment, but in the aftermath of the oil spill, the company had to suspend its dividend due to political pressure from various US government actors, including the President. It would have been stupid to sell the stock after the spill simply because it was not paying a dividend anymore. You would have been “selling low”, and it was reasonable to know that the dividends, overall profits, and stock price would be much higher 5-10 years later. How did I know that at the time? Because the company had over $100+ billion in assets on its balance sheet which it could convert into profits from reserves over time.
That’s very different from a company like Pitney Bowes cutting its dividend. Pitney Bowes cut its dividend in the past year, and had been known for raising its dividends every year since 1980 before the cut. But here is the thing: it is in the mail order business. As in, it deals with physical mail—a dying industry in the United States if I ever saw one. The profits keep declining. The earnings power for the firm is gasping for air. It will most likely go bankrupt at some point in my lifetime. With companies like that, you get the hell out and never look back. The only way Pitney Bowes does well is if it moves into another industry (thinks Wells Fargo going from the wagon to banking powerhouse), but betting on something like that is speculation, not investing.
I think Bogle’s life has been tremendously useful to the small guy retail investor. He diagnoses the right problems in the financial industry, and his solutions are very useful for people who don’t have an active interest in investing. For me, the answer is to buy companies that will be profitable for many years to come, and watch the dividends pile up so you can make new investments that do the same thing. Bogle’s primary focus is on earning market returns that allow you to build wealth. For me, it’s about collecting the cash profits that allow me to make new investments and repeat the process over and over again.