John Bogle responds to “Ask Jack” questions

Dear Jack,

I have just finished your latest book and totally agree with your analysis of Index funds vs. mutuals, as over the long run they will outperform the equity funds. My question is, however, what holding period do you recommend. That is, what is the “long run”? Is the run long enough for folks in their 70s and up to switch over a large portion of their savings to the Index funds ?

Finally, for folks in this age group, are Fixed Indexed annuities appropriate for a portion of their savings? Those products do link to the S&P500 index and, at the expense of not obtaining the full upward movement, they do protect against downturns in the index. With index funds, the Seniors might not be able to have the time to recover losses incurred in a short 7 to 10 year period.

Thanks,
Steve K

Hi Stephen,

With all respect, I believe that your question about the “long run” has more to do with asset allocation than with index funds.

Think about this: for equities, the stock market index fund is the only way to guarantee your fair share of the market’s returns, over the short run and the long run alike. The same thing is true for bonds. (I’ll leave aside here the issues of 1) percent of equities in international stocks, and 2) whether you should hold taxable or tax-exempt bonds.)

So for folks in their 70s, common sense suggests that bonds–which pay generous income and are fairly safe–should predominate the allocation, and stocks–stingy with income (and, for actively-managed equity mutual funds, pay almost nothing) and fairly risky–should make up a smaller portion.

Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high return. I’m personally not particularly smitten with most index-linked annuities, because they charge more for the “put” than its actual value. Someone (maybe Vanguard) ought to figure out a better way.

Best,
Jack

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Dear Mr. Bogle:

In your most recent book, you advocate the use of a broad-based index fund (with a greater preference for an all US equities approach) for the equity portion of ones portfolio. You emphasize that trying to guess which segment of the market will “win” in the future cannot be determined any better than the futile attempts by market gurus to time the market or select the best individual stocks (at least after taking into account the cost of financial intermediation). You also say that there is a tendency towards “reversion to the mean” of any segment of the market that is momentarily doing better (or worse) than the overall market.

Another book by a different author (Larry Swedroe’s “The Only Guide To A Winning Investment Strategy You’ll Ever Need”) also emphasizes the inherent sensibility of using a passive approach to investing. However, the author feels that certain segments of the market, such as small stocks, offer greater opportunity for larger returns due to the greater risk associated with these segments, which gets reflected in the pricing of such assets. The author recommends overcoming much of the greater risk of those market segments (or “asset classes”) by broadly diversifying within those segments using passively managed funds.

What is your view on placing greater (but certainly not exclusive) emphasis on some of the these riskier market segments by using passively managed index funds as a way of improving the returns on ones portfolio without a commensurate increase in risk?

I thoroughly enjoyed your Little Book on Common Sense Investing and am currently thinking through how to put its principles to work. The variation on your theme suggested in this other book was intriguing and I wondered how you view such “tweaks” on the general notion of passive investing that you’ve championed for so long. Your insights would be much appreciated.

Best wishes,
Jerry K

Jerry,

Good question!

Fact is, I’m not one for trying to guess which styles will outperform or underperform–or when–and the data clearly show such changes are anything but sustainable or predictable.

We’ll send you the data tomorrow on small-cap value stocks vs. the S&P 500. You’ll see that SCV underperformed from 1926 to1942 (14 years), did nothing from 1944 to 1963 (another 19 years) and again from 1968 to 1976 (eight years) and yet again from 1979 to 1999 (another 20 years). That’s a mere 61 years of the 79-year period where SCV was not a winning strategy.

Admittedly, the explosion in SCV relative returns from 1999 through 2004 was impressive to a fault. So I’d definitely advise you to follow the strategy . . . but only if you can buy the style at 1999 prices.

My guess–alas, it is little more than that–is that today will prove to be a bad time to commit your assets to yesterday’s winning strategy. So if the temptation to do so is overwhelming, just do a little teeny bit.

Good luck!
Jack

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Hi Jack!

Thank you so much for your LITTLE COMMON SENSE BOOK OF INVESTING. It is my introduction to you and I appreciate the opportunity to get to know you. Towards the end of the book you say that you don’t imagine anyone would do exactly as you advocate with an all index portfolio, holding U.S. stocks and bonds. My opinion is that I can’t imagine anyone reading the entire book and NOT doing as you suggest!

My question is this. I now realize that holding the entire U.S. Stock Market does indeed give you international exposure. However is it really enough considering the amount of outsourcing that continues to climb? And as U.S. companies realize the tax benefits of setting up shop overseas, they will eventually not even be U.S. companies any more. Is it therefore wise to have a percentage of your serious money account in a foreign index fund?

Many Thanks,
John G

Hi John,

I’m delighted that you found TLBCSI to be persuasive. I’m so pleased that it’s doing so well in the stores. After all, what good’s a sermon without a congregation?

My own belief is that the US international exposure is adequate for most investors. In fact, outsourcing makes US firms more profitable (at least in the short run!), even as the weak dollar increases foreign purchases of US goods and services, adding to their profitability. Yes, “on the other hand” (as the economists say), the weak dollar also make foreign stocks more attractive relative to US stocks, and it would take more courage than I possess to predict a stronger dollar in the forseeable future.

My traditional position was that currency fluctuations are impossible to time, and that they wash out over the long run; hence foreign holding should not exceed 20% of equities. After the strong dollar’s long run in about 1991-2001, I thought foreign stocks should in fact represent about 20%. But today, with foreign markets–particularly emerging markets–having had such a long, strong run, I’d say don’t rush to hold that position–average in over the next few years.

All of this smacks of timing, and of course it is! And I pretend no expertise in that area. But I believe that the main benefit of international diversification will not come from timing, but from a broadenede array of companies that represent the widest possible variety of leading companies. (I.e., some of the better auto, health care, and technology companies are headquartered outside the US.)

With that, you’re on your own. Hope it helps.

Jack

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Jack,

I brought your books common sense and the littlest book on audible.com. It is easy to listen to on my iPod. Enjoy listening while at the gym. Are you going to write another book?

Thanks,
Jim

Hi Jim,

I’m glad you liked my Little Book, and also enjoyed it on tape. (Though several listeners said it would have been more “alive” if I’d done the talking. Too late for that now.)

Another book? Who really knows? Writing is a disease with me, and sometimes I think that my passion for it will never stop. “On the other hand” (as the economists say), it’s demanding work. We age! And what seemed like a little hill yesterday may look like a mountain tomorrow. But, as the old saw goes, we climb it anyway, “because it’s there.”

Stay tuned, even though I can’t tell you what to listen for.

Jack