Bogleheads® 2022 Conference – Bogleheads University

00:00:00.000 | [APPLAUSE]

00:00:06.440 | Remember, Jack Bogle, you get what you don't pay for.

00:00:09.160 | It's true.

00:00:09.880 | So I want to convince you of two things.

00:00:15.920 | Get real, and arithmetic still works.

00:00:21.720 | Now, for get real, which is better,

00:00:24.040 | earning 10% when inflation is 12%

00:00:27.600 | or earning 3% when inflation is 2%?

00:00:30.040 | Which do you think makes people happier?

00:00:36.120 | We like to see the balance go up even if the spending

00:00:38.960 | power is going down.

00:00:43.040 | So stocks-- this is all speculative,

00:00:46.640 | but stocks may have a real inflation-adjusted return

00:00:50.120 | of, let's say, 5% annually.

00:00:52.480 | High-quality bonds, maybe 1%.

00:00:56.920 | So that means a 50/50 portfolio might, in the long run,

00:01:01.120 | beat inflation by 3%.

00:01:04.600 | So how much of it do you want to give away?

00:01:07.560 | Now, I ran something by Mike Piper

00:01:09.160 | on a spreadsheet last night, but I should have run this by--

00:01:12.120 | 3 minus 2 does equal 1, right?

00:01:14.600 | Mike agrees.

00:01:15.520 | He's nodding.

00:01:17.680 | So the most brilliant paper you'll ever read

00:01:21.120 | is three pages and incredibly simple

00:01:24.320 | by Nobel laureate William Sharpe,

00:01:26.480 | Arithmetic of Active Management.

00:01:29.080 | And what it says is that if the stock market--

00:01:32.680 | let's just define it as the US stock market--

00:01:34.800 | earns 10%, the average dollar invested

00:01:38.480 | is going to earn 10% less the fees.

00:01:41.440 | And by the way, that's over any period of time--

00:01:48.320 | year to date, 20 years, et cetera.

00:01:51.920 | And Rick is right.

00:01:53.240 | Over the long period of time, the total stock funds

00:01:57.880 | do better and better and better.

00:02:02.280 | So the doctor analogy-- the first time

00:02:04.120 | I met Gus Sauter, who was the chief investment

00:02:07.720 | officer of Vanguard and launched the Vanguard Total Stock Index

00:02:14.840 | Fund, he gave me this analogy.

00:02:17.000 | If you needed heart surgery, would you

00:02:19.080 | find the cheapest heart surgeon or the best?

00:02:22.680 | What's wrong with this analogy?

00:02:28.360 | And by the way, he gave me this analogy

00:02:30.320 | as what other active managers were using.

00:02:32.600 | My doctor wouldn't have to make somebody else die in order

00:02:41.200 | to make me live.

00:02:43.360 | The stock market is a zero-sum game.

00:02:46.520 | We do not live in Lake Wobegon.

00:02:48.520 | This is where 90% of us are above average.

00:02:52.160 | So how much do you want to give up

00:02:54.240 | between fees, the expense ratio, hidden fees, bid-ask, market

00:02:59.360 | impact, hedging, et cetera?

00:03:01.960 | Advisor fees, my hourly rate is a drag on returns.

00:03:07.880 | Emotions, taxes-- and remember, taxes

00:03:12.640 | are charged on a nominal basis, not inflation-based.

00:03:19.040 | So I showed you this slide earlier.

00:03:21.520 | And again, it's incredibly important,

00:03:23.960 | the cost of emotions.

00:03:26.880 | Those are very, very large--

00:03:28.840 | 1.7%.

00:03:30.920 | So if you think about it, if a 50/50 portfolio

00:03:34.560 | might earn 3% above inflation, if we pay 1% in fees

00:03:41.520 | to the fund managers, our financial planner, investment

00:03:45.240 | advisor, et cetera, we give up another 1.7% in emotions.

00:03:49.920 | And the government taxes us.

00:03:51.800 | That tax number is much lower because the active fund

00:03:55.440 | is going to have lower returns and be

00:03:58.520 | a little bit more tax-efficient from that standpoint, which

00:04:01.240 | is not a good thing.

00:04:03.000 | So maybe the average investor loses 0.7% of spending power.

00:04:10.380 | This is illustrative.

00:04:12.640 | So the Vanguard Total Stock Index Fund--

00:04:15.880 | Christine showed this slide.

00:04:17.120 | Boy, I'm really glad that we both came out

00:04:18.880 | with 4,052 holdings.

00:04:22.840 | An expense ratio of 0.03% plus Vanguard

00:04:27.280 | returns all the profits from securities lending.

00:04:30.320 | So the net cost is even less than that.

00:04:32.960 | The total capital gain distributions

00:04:35.000 | over the last 10 years is zero.

00:04:37.680 | And by the way, a lot of active fund holders

00:04:41.660 | are going to get 1099s this year when their value has gone down

00:04:47.340 | because they've sold stocks within the portfolio.

00:04:51.780 | So mathematically, the average dollar

00:04:54.780 | invested in US stocks over any period of time

00:05:00.460 | must be higher for Vanguard Total Stock

00:05:03.780 | than active funds, right?

00:05:07.380 | This next slide from a research company--

00:05:10.440 | I shouldn't have used their name--

00:05:14.440 | it was very, very stressful to me

00:05:17.760 | because what it shows is that the Vanguard Total Stock Index

00:05:21.520 | Fund underperformed its peers by 1.7%,

00:05:27.880 | and 73% year-to-date of mutual funds

00:05:32.680 | bested the Total Stock Index Fund.

00:05:35.920 | I can't tell you how stressful that was for me

00:05:37.900 | and how much research I spent to get to the bottom of it.

00:05:42.460 | And how I got to the bottom of it

00:05:44.860 | is what Rick showed is that the S&P 500 Index Fund year-to-date

00:05:49.140 | beat most of its peers.

00:05:50.780 | And then there's another fund out there

00:05:52.380 | called the Extended Market Index Fund, which

00:05:55.460 | are every company based in the United States that's

00:05:58.740 | not in the S&P 500, and both of those beat their peers.

00:06:02.980 | So how could the sum of the two beat their peers?

00:06:07.400 | And John Reckenthaler helped me get to the bottom of this.

00:06:12.560 | Morningstar has changed the way it looks at the total market.

00:06:16.240 | It used to be a third growth, a third value, and a third core.

00:06:20.560 | Now growth is much larger.

00:06:24.560 | So I argue the market is the market.

00:06:27.080 | It's neither growth nor value.

00:06:28.480 | If you own everything, you own everything.

00:06:31.600 | So John Reckenthaler is just absolutely brilliant.

00:06:34.840 | And you really know somebody who's

00:06:37.360 | good when you disagree with them,

00:06:38.920 | and they get to the bottom of things.

00:06:40.920 | So as he puts it, owning a low-cost, market-cap-weighted

00:06:44.560 | index fund is both psychologically

00:06:47.200 | and mathematically superior.

00:06:49.760 | So we hate to lose money.

00:06:51.040 | I've lost money this year.

00:06:53.280 | But I know that I've lost less money in the US market

00:06:56.440 | than most other people.

00:06:59.320 | So the most important sentence I've ever written on investing

00:07:03.000 | is minimize expenses and emotions,

00:07:05.480 | maximize diversification and discipline.

00:07:09.240 | It's that simple.

00:07:12.080 | So conclusion, you can have a bad low-cost portfolio,

00:07:15.760 | but you can't have a good high-cost portfolio.

00:07:19.480 | I could have had everything in a low-cost Russian index fund,

00:07:22.560 | and that wouldn't have worked out all that well.

00:07:25.440 | Not very diversified.

00:07:27.240 | So John Bogle gave us access to low-cost and high

00:07:30.800 | diversification.

00:07:32.160 | It's up to us to manage discipline and emotions.

00:07:37.000 | Smart beta was the rage about 10 years ago.

00:07:40.360 | Let's put everything in value, equal-weighted, small-cap,

00:07:45.160 | momentum.

00:07:46.400 | And that's active investing.

00:07:49.040 | I embrace dumb beta, which Christine was nice enough

00:07:53.040 | to interview me on The Long View and appropriately titled

00:07:57.160 | Why I Embrace Dumb Beta.

00:07:59.280 | So understand what Jack Bogle meant

00:08:02.040 | by the tyranny of compounding, of costs

00:08:05.400 | on our financial freedom.

00:08:07.120 | Costs must be low, diversification high.

00:08:12.680 | you

00:08:14.740 | [BLANK_AUDIO]

Bogleheads® 2022 Conference – Bogleheads University – Principle 7: Keep Costs Low

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