A Little Book

Looking through my post history, it was way back on January 1st 2013 that I wrote that a particular finance book ("A Random Walk Down Wall Street") might be the last financial book I ever read. Why? Because it reinforced the ideas I'd already been following in my personal investing life for the previous decade without adding anything substantially new. By this point I felt confident that I knew everything I needed to know.

Obviously, though, that wasn't the last finance book I read! It's been an interesting topic for me and something I continue to dip into. Some of it has to do with the political, social, legal or broader economic ramifications of finance; but I also sometimes pick up a pure personal finance book, with absolutely zero expectation it will change, let alone improve, my finances.

So why do I keep reading them? I've been mulling it over, and the best analogy I have is that of a religious practice. An observant religious person will regularly attend church or temple services. Why do they do this? Not to be convinced of the rightness of their faith. After a few years, it won't even be to learn more about the faith: sure, there may be some points of theology to discuss, but they've already embraced the core message of their religion. So why do it? Well, for many other reasons, including being part of a faith community, reinforcing their beliefs, coming to deeper and stronger understandings of tenets that they may feel unsure about, being prompted to think about how to apply their specific day-to-day situation to their timeless religious belief.

I don't want to say that personal finance is a religion - it benefits from observable quantifiable data and trends in a way that faith by definition cannot - but adhering to a certain financial practice does involve following a big-picture philosophy as well as applying that philosophy to daily decisions in a way that feels somewhat familiar. Do you follow the Boglehead practice or the Wall Street Bets heresy? Do you adhere to the Total Return creed or are you a Dividend Gang apostate? Has Cryptocurrency entered your pantheon of Acceptable Investment Vehicles? Most importantly of all, when the market inevitably tanks, will your faith be strong enough to stay the course during the storm, or will you flee and be lost?

That's a VERY long intro to say that I recently start, read, and finished "The Little Book of Common Sense Investing" by the late, great John Bogle. I've read multiple books of Bogle's, listened to speeches and interviews from him, and much of my personal finance reading comes from what could be considered the Extended Bogle Universe. I can't say that there's anything "new" in this book, in the sense of additional information or instruction that will cause me to change my behavior. But it was still a really enjoyable read, reinforcing the path I've happily been following, giving encouragement to continue the journey and providing some additional depth and color to familiar topics.

 

This book repeats a lot of little sayings and aphorisms from Bogle. One early one that I really like goes something like "Successful investing is simple, but it isn't easy." He makes a great analogy to dieting. Everyone knows the "secret" to losing weight: eat less and exercise more. If knowing was all that it took, everyone would be at their ideal weight. Knowing what to do is simple, actually following through with it and staying the course is incredibly challenging. So it is too with investing. The basics are very straightforward: live below your means, invest in low-cost equity funds for a very long time, and don't touch your investments until you retire. Actually following that path is a lot harder: it takes discipline, faith, and focus.

The main focus of this book is the advantage of passive index investing over actively managed investments. That's very old news to me at this point, but Bogle gives a detailed and thorough walkthrough of the reasons why indexing has an advantage and just how significant that advantage is. Compounding costs are just as important as compounding returns, and spending an extra 1% or so on expense ratios can have a huge impact on cumulative earnings over long periods of time; in some realistic scenarios over two or three decades, an index fund may realistically end with twice the value as an active fund.

There is some new stuff in this book, one of the most interesting a detailed look at all of the specific actively managed funds over a two-decade period. Many of them didn't even survive the period, shut down and folded into other funds. Bogle finds that, of the 300 that did survive, only 3 had greater returns than the S&P 500 index fund. And of those, two funds' returns were mostly due to extraordinary performance in their first years: most of the money flowed in after those stellar years, and the subsequent performance lagged the S&P 500. So a mere 1 in 300 funds actually managed to beat the index - astonishingly poor odds! Why take that risk?

The end of the book covers some retirement topics, which has been on my mind recently, particularly with reading How To Make Your Money Last. This book is less thorough than that one, but hits some good notes in its briefer duration. There's a particular focus on the utility of Social Security. Bogle has an interesting suggestion of treating social security like a bond: it's a low-risk and low-volatility source of regular income. So, assuming you receive Social Security, you may want to tilt more towards equities than bonds to hit a desired allocation; if you want to be 50/50 equities/bonds, your investment portfolio could be more like 60/40. Bogle gives some math for calculating this, coming up with a capitalized value for the stream of income generated by Social Security; this process has some arbitrary choices but seems well thought-through.

This really is a little book, with small pages and not many pages. The chapters are short and pithy. There's a great focus on memorable quotes, with Warren Buffet prominently featured along with various economists, finance experts, and business leaders.

One thing that was kind of unclear to me early in my investing career was just why I should be investing in stocks: I understand the concept of bonds, getting interest in exchange for loaning money, but just owning a share in stock seems kind of meaningless since no money flows to the company as a result of the security purchase, so why does it increase in value more than a bond? Bogle gives a brief but really excellent explanation of value, dividing it into business fundamentals versus market opinions. This follows the same analysis as A Random Walk Down Wall Street, and I was happy to see Bogle quoting Malkiel. Over the long run, you're an owner of businesses that make money, so you expect to share in their profits. That's the real fundamental return, which will be realized through dividends or reinvestment (and reinvestment resulting in a wealthier company and thus higher share prices). But in the short term the value assigned to those profits may vary widely. The most important thing for you to do as an investor is to tune out the noise. Don't try to predict market swings, which are irrational and emotional, and just stay invested for the long haul. Sooner or later prices will return to reflecting the fundamental value.

For fundamentals, Bogle long posited a simple formula: take the current dividend yield of a stock, and add its projected growth. The sum of these is its future earnings. When you buy a stock, you're essentially buying forward earnings: the profit it will return in the future. You can thus calculate price/earning ratios and determine whether individual stocks and the market as a whole are cheaper than the historical norm, more expensive, or around the same range.

The US stock market's P/E ratio has been really high for quite a while now. Bogle and his successors at Vanguard have always predicted a return to the mean, which is a gentle way of saying either a large and sudden decline in stock prices or a long stagnant period while the economy catches up to the inflated valuation. That hasn't happened yet, even in the seven years since this edition was published. I tend to think that we're overdue for a correction, and I'm instinctively skeptical of any arguments that "the rules have changed"; but over the last years I have started wondering whether external factors like longer life expectancies increase the actual utility of those forward earnings, in such a way that a higher P/E ratio is sustainably justified? And the George W. Bush tax cuts (which I HATE) slashed the long-term capital gains tax, which makes each dollar in profit worth more post-tax, so that may also increase the actual value of a nominal profit. Even if the above suppositions are correct, that doesn't mean that P/E will increase indefinitely, but it's possible (only possible! not probable!) that there's a stable, long-term equilibrium (mean) at a higher level in the 21st century than there was in the mid-20th century.

My fear, though, is that the higher P/E ratio is more a matter of competition and scarcity, a purely demand-driven inflation rather than a supply-driven increase in utility. This could be the case as a result of more direct market participation, particularly as a result of the shift from pensions into 401(k) plans and automatic investing. That feels much less sustainable to me and would point more towards a strong correction.

One benefit of Bogleheading is that all the above doesn't matter - you just want to own the market and get your fair share of whatever it returns. It may be less or more than the historical average, but over the long run (of multiple decades) you'll always be better participating in the market than sitting it out. There have been numerous times in the past when I was confident that a correction was imminent, most recently in 2016 after the Presidential election, and felt tempted to pull all my money out; I'm glad that I opted for laziness, which gave me a much better result! Another Bogle aphorism that I love is "Don't do something, just stand there!"

I really like Bogle's voice, in this book and all of his writing and speaking. He's opinionated and frank with just enough humility. He's been proven right over and over again throughout his career, which understandably lends some confidence to his pronouncements, even if those pronouncements kind of boil down to "We're all just dummies, myself included." I was particularly interested in his discussion of the role of international equities in a portfolio. As he points out, literally everyone other than him (including everyone else at Vanguard) recommends including international exposure, while he's always favored a US-only portfolio. To his credit, in the time since his book was published, you'd still have been better off investing US-only. I feel like that has to change sometime, but again, I've been wrong before!

Reading this book now has felt rather timely, due to some major changes at Vanguard over the last month. They're making a big overhaul to their fee structure, adding new charges for accounts with less than $5 million (!!!) in assets. As a company that has always been defined by rock-bottom expenses, that feels like a huge shift. And just a few days ago, they announced that they're hiring a new CEO, Salim Ramji. Salim was previously at Blackrock, but prior to that he was a consultant at McKinsey, which is very worriesome to me. Salim will be the first Vanguard CEO to not have worked under Bogle, and the first to come from outside the company.

I've been a happy Vanguard customer for (I think) 20 years, but I am keeping an eye on things and seriously considering relocating. These days, most people in my online communities prefer Fidelity, which charges even lower fees, has better customer service and a better app and website. I've been sticking with Vanguard in large part because of their mutual structure: like a mutual insurance company, it's owned by the customers, which aligns the incentives for low costs; but the actual benefits of Fidelity may outweigh the theoretical advantages of Vanguard, and at some point my unhappiness may overcome my inertia and make me switch over.

Anyways! I've enjoyed all of Bogle's books I've read so far. I think "Enough." is still my favorite, as it ventures furthest afield from the technical aspects of investing to share some great life wisdom. I think that by now anyone who's genuinely interested in investing has a solid understanding of index investing, so this book is probably less impactful now than when it first came out, but it could be a helpful resource to people in the earlier stages of their investing journey. For the rest of us, it's like a good Sunday service, refreshing our convictions and keeping us on a good path.