For those equity investors that read the compelling message provided by this book and follow author John Bogle's advice, the book might have several other compelling subtitles, such as "Relentless arithmetic proves it's almost impossible to outperform a low-cost index fund", or "Equity investors: find a less expensive/more profitable hobby! Like investing in a low-cost index fund!", or, more simply, "Most mutual funds suck!".
This book, by the father of the index-investing movement and founder and former head of the Vanguard Group uses "relentless arithmetic" to prove exactly why individual investors will, as an average, dramatically underperform the market averages (about 9.5% annually over long periods of time, according to the book). Bogle has been a persistent critic of traditional mutual funds, which have an excessive average cost of 2.5% annually, compared, for instance, to the Vanguard index fund cost of just 0.19%. Bogle has been a critic because, despite the high cost of a conventional mutual fund, it doesn't, on average, outperform a low-cost index fund.
Just considering the mutual fund cost portion of the drag (about 2.5% annually), this book shows that, compared to investing in the index, after 30 years, the typical mutual fund equity investor will only get about 50% of the market advance. After 50 years, this will decline even further, to only 31% of the total advance.
These dismal averages don't even consider the propensity of investors to trade in and out various funds, ETFs, or stocks (transactional costs), nor the further drag of picking the wrong funds. These are significant sources of further underperformance.
Bogle punctuates this message by regularly providing quotes from famous value investors and business school professors, to further support low-cost index investing. In some ways, I felt like the book was a form of Chinese water torture: at the end, it was all but impossible to dismiss its message. And that message is that low-cost index-fund investing is the "only way" to get your fair share of market returns. As the book puts it, "by aiming for the average, you can beat the average".
In summary, the book shows the three sources of underperformance - which are very significant in their totality - which is likely for average equity investors:
- Excessive costs of conventional mutual funds;
- Transactional or trading costs as investors trade in and out of various funds/stocks etc. and;
- The costs of picking the wrong funds (investor pile into funds which have risen lately, and history shows most of these are poised for a period of underperformance; and visa-versa).
In a separate future posting, I am, however, going to take on one of Mr. Bogle's final messages: that some of the new products and new market indices aren't likely to provide superior returns any better than tracking conventional market capitalization-weighted indices (S&P 500 is one such index, and most widely-quoted indices are of this type). I believe this to be false, and hope to explain why I think so, using mostly Mr. Bogle's own words to explain why.
No matter this relatively small dispute, I recommend that all investors unfamiliar with the huge advantages of low-cost index investing buy and read this book.
The Confused Capitalist