Common Sense on Mutual Funds, Updated 10th Anniversary Edition

by John C. Bogle

The index strategy, by definition, must provide less-than-market returns—but only by a slight margin. And that is the true holy grail: achieving through a diversified investment portfolio a return that is as close to 100 percent of the market return as is possible.

One of the investment principles least recognized by individual investors—reversion to the mean, that eternal force of gravity that seems to hold the financial markets in its grip—remains a fact of life in the world of investing.

What ever goes up must come down and whatever goes down must come up.

if you share in the powerful and rarely challenged ethos of our era—that common stocks are virtually certain to provide the highest returns of any major asset class over the long term—a substantial portion of your program may well be invested in equity funds.

No one knows what future returns the financial markets will provide.

The basic law would be to go agressive on equities considering the time horizon and eventually keep introducing the debt component as the time goes on.

A decision to own an all-stock market index fund also solves the problem of fund selection. Why fly in the face of historical evidence by trying to select individual mutual funds in the hope of picking a big winner?

RTM suggests that its long-run returns will closely parallel those of the total market. Given low costs, either index fund should provide investors with the best possible opportunity to earn returns approaching 100 percent of the market return.

If the question were simply “Did the professional investment advisers outpace the market over the past 15 years?” the answer is clear. Most advisers did not. Indeed, as a matter of basic mathematics and elementary logic, most advisers cannot outpace the market over the long run.

What makes you think your mutual fund will out perform ?

Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom. . . . Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience and usually also to give to speculation the deceptive guise of investment. . . . Have not investors and security analysts eaten of the tree of knowledge of good and evil prospects? By so doing have they not permanently expelled themselves from that Eden where promising common stocks at reasonable prices could be plucked off the bushes?

Fancy formulaes and calculations are to be kept away. Keep it simple and no complications.

The pattern is familiar: profound reversion to the mean (RTM),

It seems clear that funds that have created a record of remarkable returns at relatively small asset levels have a pronounced tendency to lose that edge when they get large.

The main reason to stay away from a big asset size.

To put it simply: A tax that is deferred is the functional equivalent of an interest-free loan from the U.S. Treasury Department, with a maturity equal to the number of years of deferral.

Why are you so eager to pay the government ?

Time and Reward—The Magic of Compounding

The ultimate reality.

Descending the slope of risk is far easier than ascending the slope of reward.

Its more important to avoid bad things than do good things.

Reward and risk go hand in hand. The conventional wisdom of finance teaches that if one is to increase (or decrease), so must the other. Cost has a significant impact on both reward and risk. Lower costs make it possible to earn a higher return without assuming extra risk, or to hold reward constant and reduce risk. And because the passage of years multiplies the aggregate reward, moderates the volatility risk, and magnifies the burden of cost, time interacts with each of the three spatial dimensions of investing.

During the long voyage that you take to reach your goal of accumulating capital, the financial markets will inevitably experience crosscurrents, tidal shifts, high winds, rough seas, and rugged storms.

But those of you who are looking to far horizons, who are able to accept a bit more short-term risk in the pursuit of enhanced long-term returns, who are conscious of the destructive power of cost, and who are able to use time to its highest advantage will win the battle for investment survival, if only you have

place. It is the “management” fees paid by the fund shareholders that are being poured into these marketing efforts

Index funds usually outpace about 60 percent of their peers in a given year, albeit 80 percent or more over longer time frames.