Six Lessons for Investors

Vanguard founder and index fund proponent John Bogle lists six lessons investors learned in 2008 as follows:

1) Beware of market forecasts, even by experts. Ignore the forecasts of inevitably bullish strategists. Bearish strategists on Wall Street's payroll don't survive for long.

2) Never underrate the importance of asset allocation. Consider not only the probabilities of future returns on stocks, but the consequences if you are wrong.

3) Mutual funds with superior performance records often falter. Managers of funds seeking market-beating returns should make it clear to investors that they must be prepared to trail the market -- perhaps substantially -- in at least one year of every three.

4) Owning the market remains the strategy of choice. In sum, active management strategies as a group lose because they are expensive. Passive indexing strategies win because they are cheap.

5) Look before you leap into alternative asset classes. Always keep in mind: When the investment grass looks greener on the other side of the fence, look twice before you leap.

6) Beware of financial innovation. Why? Because most of it is designed to enrich the innovators, not investors.

In particular, I like this paragraph:

Indexing won in 2008 by an especially wide margin. Low-cost, low-turnover, no-load S&P 500 index funds outpaced nearly 70% of all equity funds, and (admittedly a fairer comparison) more than 60% of all funds focused on large-cap U.S. stocks. This continues the pattern -- with some variations -- that goes back to the start of the first index fund 33 years ago. The bond index fund did even better. Its return of 5% for 2008 outpaced more than 80% of all taxable bond funds.

A few of my thoughts on each of these:

1. I would say, "Beware of market forecasts, ESPECIALLY by experts."

2. I think many of us learned this lesson in 2008.

3. I've read time and again that regularly buying last year's top-performing actively managed mutual fund is a losing strategy.

4. Costs matter big-time in investing, that's one reason I invest in index funds. And even using these, I've taken additional steps to make sure my investing costs are as low as possible.

5. Ha! Don't I know it. Learned this lesson the hard way early in my investing days.

6. Unfortunately, much of the "financial services" industry is designed to turn your money into their money. That's why I advocate a DIY approach to managing your money and supplementing with advisors only when needed.

Comments

[rwh]

For the last several years I have repeatedly read or heard financial experts state the old rule of thumb that your portfolio should be your age in bonds (a 30 year old should have 30% bonds, a 70 year old should have 70% bonds etc.) was outdated. Their recommendations ALWAYS skewed higher toward stocks.

I recently heard Mr. Bogle state the old rule of thumb is a good one and he currently has only about 30-35% in stocks, the rest in bonds.

[Fidelity Select Fundranker]

Indexing may have won in 2008 over actively managed funds, but the S&P 500 was still down 37% for 2008 (Ouch!). Fundranker was down 38% in 2008, so it must have outperformed a lot of actively managed funds, as well. The Fundranker system outperformed the S&P 500 in eight of the last 12 years, many times by substantial margins.

[Mike]

@Fidelity Select Fundranker
If you include your costs it outperforms the S&P500 or before costs? A 100 dollars a year, currently is an extra share of SPY.

[Mike]

@FMF

I was actually wondering this the other day. How can you advocate the Fidelity select fundraker system when their fees seem enormous??

[Neal Frankle]

Great and important lesson. One other resource would be DFA funds. They offer very low cost and have done fabulous job for investors. I don't know if they are open to individuals but if so, I suggest checking them out.

[Dave]

FMF, out of context, the first point above is a little confusing. I assume what it means is that BOTH bullish and bearish "strategists" are usually wrong, so it's wise to go with index funds over strategists of any kind.

The paragraph you point out is also a little deceptive, IMO. True, the S&P outpaced 60% of funds, but it was STILL down 38% for the year, wiping out all returns over the past decade. That's still a bitter pill to swallow.

In any event, I am a true believer in buy and hold for the LONG TERM. BY FAR, the hardest part of buying index funds -- and (unsurprisingly) it doesn't get nearly enough attention as it should -- is ASSET ALLOCATION. There are a million different ways to diversify over space and time, even using all low cost index funds. It's very hard to figure out what the best asset allocation is for any individual.

[FMF]

Mike --

I don't buy actively managed funds (as you know) but many of my readers do. As such, I felt introducing them to a service that helps pick funds (especially good funds which Fidelity generally has -- my 401k is with them) was worthwhile (especially with the discount). From there, readers can make up their own minds whether or not to subscribe to the service.

[Fidelity Select Fundranker]

Mike, $99 per year is enormous? If you invest $24,000 across eight funds, which Fidelity Select Fundranker advocates, that is less than 1/2% per year. Yes, Fundranker has beaten the S&P 500 by much more than that in eight of the last 12 years. Not 2008, I admit, but it was close. Please look at the historical info for Fundranker on the website.

[Mike]

@ Fidelity Select Fundraker

The last I checked SPY has a 0.08% expense ratio which means that you would have to invest $123,750 to get to that level. So, yes, I think that is rather expensive :-D.

[Fidelity Select Fundranker]

Mike, we'll have to agree to disagree. I remember a post on FMF about spending money to make money. I think the Fundranker service is a case in point. If you can outperform the S&P 500 pretty substantially and pretty consistently, then you are way better off in the long run.

[kitty]

"The bond index fund did even better. "
A performance during one year when we had credit crisis and continually lowered interest rates is hardly indicative at least with regard to bonds.
80% of these bond funds index was compared against could've been heavily weighted towards financials. Many banks went out of business in 2008, many banks and insurers had their credit rating lowered.

I don't see a huge reason to hold bond funds (as opposed to individual bonds). In my taxable, non-retirement account, I have individual bonds - municipal and corporate. Not many yet, but I plan to buy more while the yields are attractive. I can sell them when the yields stop becoming attractive (the value of bonds goes up enough that the interest rate paid results in low yield) or I can chose to hold to maturity if this doesn't happen. In my 401K, I bought a couple of funds with investment grade bonds, but a) I checked which bonds they invest in b) bought at the height of credit crisis when the yields were astronomical. I don't plan to hold these bond funds. I plan to move money to either stable value or stocks or both (depending on the economy and my desired allocation) as soon as the spreads between corporate bonds and the treasuries become more reasonable or when the economy starts improving (at which time there would be a strong chance of interest rates going up.

Here are the reasons I don't like bond funds:
1) unlike individual bonds that come with a promise to repay money at maturity, bond funds don't have maturity date. Hence you don't have an option of holding to maturity and getting your money back and getting fixed income until then.
2) When the interest rates go up the value of bonds goes down. All bonds - index, selected bonds. Sure, you get higher yield on new bonds your fund may buy, but it'll take years to offset the loss in value. When you need to get your money out of the fund, you get whatever is there at the current market value. If at the time the interest rates are high, you can lose money. The interest rates cannot go down any more and with all the money being thrown at the economy, at some point interest rates are bound to go up.
3) Some companies will still go out of business. Many financial companies will still have their credit rating reduced. I don't want to hold bonds in these companies, but the index bond fund is bound to contain them.

I think when people try to apply diversification from stocks to bonds they forget or are ignorant of fundamental difference between stocks and bonds. You think you are reducing risk when holding bond funds vs holding individual bonds, but you are forgetting that I can hold individual bonds to maturity...