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John Bogle: Retirement Investors Leave 80% On The Table
You asked about how John Bogle arrived at his assertion that investors leave approximately 80 % of achievable rewards on the table.
The power of compounding is the simple answer. Saint John arrived at his startling number from his favorite topic: the excessive costs imposed by actively managed mutual funds, and the incremental additional costs coupled to their trading frequency and market research. These continuing charges are also subject to the tyranny of compounding over time, and operate in a wealth robbing way.
So, Bogle’s analysis is based on accumulating shortfalls over time. He gets his shortfall by using a 65 year investor timeframe that includes both an earning phase and a retirement phase. He postulates an active fund cost of 2.5 % over the entire timeframe such that the investor only receives 5.5 % annual return from an equity marketplace that produces an annual 8.0 % return.
Now it’s a simple calculation to get his critical number. It is the ratio of (1.055/1.080) taken to the 65th power. That’s 0.218 or about 80 % (actually 78 %) taken from the possible equity investment table.
Bogle used the 65 year timeframe to emphasize his point. That’s just a tad excessive.
But his analysis only viewed the issue as a penalty associated with fund management costs. The real world issue is exasperated by poor individual investor timing errors and investor misbehavior. The DALBAR studies have documented this misbehavior for many years.
Here is a Link to an early 2013 news article that characterizes investor returns for timeframes extending to two decades that was extracted from the DALBAR data sets:
It is not a pretty picture. The DALBAR study shows that the average private investor has underperformed the equity market by a huge margin over the 20 year time horizon. During that period, the investor gained a disappointing 4.25 % annually while the S&P 500 delivered 8.21 % per year. Therefore, the investor recovered (1.0425/1.0821) taken to the 20th power, or only 47.4 % of the equity market rewards.
If you consider the same 65 year time-span that Saint John used, the ratio becomes a ruinous 8.86 % of the accessible market returns. The average investor suffers greatly from both the penalty of active fund management costs and practices, and his own foolish behavior.
That’s the bad news. The good news is that we investors seem to be slowly learning over time. The most recent 3-year DALBAR data summary shows an investor performance improvement. More recently, we captured a higher fraction of the market returns as follows for the 3-year timeframe: (1.0763/1.1087) taken to the 3rd power yields 91.48 % of the market return. If that ratio is maintained for a 20 year period, the investor recovers 55.3 % of equity rewards. That too is devastating to end wealth, but it is an improved prospect over the 20-year performance data.
Of course, the obvious question is, why not just buy the S&P 500 Index fund or a diversified portfolio of Index products? Index products are gaining momentum among both the private and the institutional classes of investors.
DALBAR will be updating their survey in March, and will release results that include 2013 data at that time.
Compounding is so powerful a factor that economists and real estate wizards believe that we overpaid the Indian tribes when we purchased Manhattan island from them centuries ago with trinkets valued at roughly 25 dollars. I’m not sure I trust that analysis.
Agreed, MJG. Like where were the Indians going to invest their goods (and it was 64 guilders, perhaps worth more like $1000)? And there is the rumor the Indians were just passing though.
As to Saint John's allegation: I'm pretty sure he's correct; and all of us on this site are overt or closeted market timers. I'm still looking for the local chapter of MTA (Market Timers Anonymous) where I can stand up, give them a false name, and say "Hello, I'm Fred, and I'm a market timer," and find a counselor I can call when I feel the urge to buy a fund or stock recommended here or elsewhere. (Darn, but PYSAX looks interesting. Guess I'd better find a mid-cap index.) They probably smoke less than those folks at AAA, also.
In an attempt to curb this addiction, I am trying to buy an equal amount of an index fund for every actively managed fund I buy. This has at least limited my purchases and slightly increased my index holdings (naturally, I'm way behind, because my 403b is at Fido, where I have a lot of Spartan purchases to make up).
Reply to @MJG: Thank you for reminder. There is no free lunch. Few active managers out-perform their respective indeces consistently over long period of time. Love to invest with DFA funds but that requires more fee with DFA approved advisors.
For retirement savers, Bogle is correct. Don't just do something, STAND there. I've made very few changes along the way. One has to be in touch with the news. But I think there's a difference between "market-timing" and adjusting to big-wave macro-trends.
You noted: "and all of us on this site are overt or closeted market timers."
"In an attempt to curb this addiction, I am trying to buy an equal amount of an index fund for every actively managed fund I buy."
>>> Ah, hell; I know I would do battle with any advisor I could have or would likely meet in the future as to why they have a better plan. Not that very good advisors do not exist; but many also suffer from the same directional tugs of emotion and rationalization of factors as any other human.
I agree that most here are dynamic investors; otherwise there would be no need to ever visit this site. See, I even attempted to rationalize our behavior with the words, " dynamic investors" in place of: "overt or closeted market timers."
If our house held 10 etf or index funds, we would still attempt (over time periods) to adjust the mix as we viewed market turns and moves; relative to own risk/reward profile.
One may suppose that attempting to further manage our portfolios among active managed funds may add another layer of "meddling". Perhaps.....
IMO, the mix of index or active managed funds is the basis for some decision making. If one has all etf/index funds; then you may want to freely play with these holdings, as you and the markets dictate. If a 50/50 mix of active and passive; perhaps (although always watching) let the active folks who have a nominally decent track record continue their forward march and then play (if one can't shake the fix) with the passive areas.
For those so inclined to the observation of allocation mix; the above does not include this most personal decision area.
I'll stand next to you (Market Timers Anonymous) to profess that this house does meddle from time to time with the holdings in the portfolio. The critical part of this is that we realize the circumstance. The danger zone may be for those who do meddle too much and don't recognize the event for what it may signify.
Reply to @MJG: Thank you for your, as always, well researched and carefully reasoned analysis.
From your response "He postulates an active fund cost of 2.5 % over the entire timeframe such that the investor only receives 5.5 % annual return from an equity marketplace that produces an annual 8.0 % return.
I'm no expert (and also short on time today) .... but that 2.5% figure strikes me as a very large gap in performance. It may well represent some kind of "average" (which includes those herded into front loaded funds). But, geez, those who read the board or follow funds closely ought to be able to do better than that in their selection of actively managed funds and, I think in many cases, outdistance the indexes over shorter time frames.
This is not to refute what I think is the underlying point in all this that over VERY long periods of time, indexes will outperform the aggregate of all actively managed funds. Nonetheless, I think most of us would agree that for certain investors in certain phases of their investing career, actively managed funds can offer some advantages. Regards
I completely agree that averages can be misleading, especially when taken out of context and/or when not augmented with other statistical inputs like timeframe, population surveyed, and dispersion measures.
Actively managed mutual funds can contribute excess returns to a portfolio cobbled together and diligently monitored by a well informed, experienced, committed, and nimble individual investor. All this takes time.
One overarching secret to successful investing is that no single secret exists that applies to all personal situations and/or market circumstances for all time. Change happens.
Although these characteristics may appear to conflict, I suspect that both patience and flexibility are necessary traits. These are not mutually exclusive personal qualities.
Comments
You asked about how John Bogle arrived at his assertion that investors leave approximately 80 % of achievable rewards on the table.
The power of compounding is the simple answer. Saint John arrived at his startling number from his favorite topic: the excessive costs imposed by actively managed mutual funds, and the incremental additional costs coupled to their trading frequency and market research. These continuing charges are also subject to the tyranny of compounding over time, and operate in a wealth robbing way.
So, Bogle’s analysis is based on accumulating shortfalls over time. He gets his shortfall by using a 65 year investor timeframe that includes both an earning phase and a retirement phase. He postulates an active fund cost of 2.5 % over the entire timeframe such that the investor only receives 5.5 % annual return from an equity marketplace that produces an annual 8.0 % return.
Now it’s a simple calculation to get his critical number. It is the ratio of (1.055/1.080) taken to the 65th power. That’s 0.218 or about 80 % (actually 78 %) taken from the possible equity investment table.
Bogle used the 65 year timeframe to emphasize his point. That’s just a tad excessive.
Here is the Link that documents his assumptions:
http://www.cnbc.com/id/101381010
But his analysis only viewed the issue as a penalty associated with fund management costs. The real world issue is exasperated by poor individual investor timing errors and investor misbehavior. The DALBAR studies have documented this misbehavior for many years.
Here is a Link to an early 2013 news article that characterizes investor returns for timeframes extending to two decades that was extracted from the DALBAR data sets:
http://www.forbes.com/sites/tomanderson/2013/03/28/fund-investors-lag-as-sp-500-nears-all-time/
It is not a pretty picture. The DALBAR study shows that the average private investor has underperformed the equity market by a huge margin over the 20 year time horizon. During that period, the investor gained a disappointing 4.25 % annually while the S&P 500 delivered 8.21 % per year. Therefore, the investor recovered (1.0425/1.0821) taken to the 20th power, or only 47.4 % of the equity market rewards.
If you consider the same 65 year time-span that Saint John used, the ratio becomes a ruinous 8.86 % of the accessible market returns. The average investor suffers greatly from both the penalty of active fund management costs and practices, and his own foolish behavior.
That’s the bad news. The good news is that we investors seem to be slowly learning over time. The most recent 3-year DALBAR data summary shows an investor performance improvement. More recently, we captured a higher fraction of the market returns as follows for the 3-year timeframe: (1.0763/1.1087) taken to the 3rd power yields 91.48 % of the market return. If that ratio is maintained for a 20 year period, the investor recovers 55.3 % of equity rewards. That too is devastating to end wealth, but it is an improved prospect over the 20-year performance data.
Of course, the obvious question is, why not just buy the S&P 500 Index fund or a diversified portfolio of Index products? Index products are gaining momentum among both the private and the institutional classes of investors.
DALBAR will be updating their survey in March, and will release results that include 2013 data at that time.
Compounding is so powerful a factor that economists and real estate wizards believe that we overpaid the Indian tribes when we purchased Manhattan island from them centuries ago with trinkets valued at roughly 25 dollars. I’m not sure I trust that analysis.
I hope this satisfies your question.
Best Wishes.
As to Saint John's allegation: I'm pretty sure he's correct; and all of us on this site are overt or closeted market timers. I'm still looking for the local chapter of MTA (Market Timers Anonymous) where I can stand up, give them a false name, and say "Hello, I'm Fred, and I'm a market timer," and find a counselor I can call when I feel the urge to buy a fund or stock recommended here or elsewhere. (Darn, but PYSAX looks interesting. Guess I'd better find a mid-cap index.) They probably smoke less than those folks at AAA, also.
In an attempt to curb this addiction, I am trying to buy an equal amount of an index fund for every actively managed fund I buy. This has at least limited my purchases and slightly increased my index holdings (naturally, I'm way behind, because my 403b is at Fido, where I have a lot of Spartan purchases to make up).
"In an attempt to curb this addiction, I am trying to buy an equal amount of an index fund for every actively managed fund I buy."
>>> Ah, hell; I know I would do battle with any advisor I could have or would likely meet in the future as to why they have a better plan. Not that very good advisors do not exist; but many also suffer from the same directional tugs of emotion and rationalization of factors as any other human.
I agree that most here are dynamic investors; otherwise there would be no need to ever visit this site. See, I even attempted to rationalize our behavior with the words, " dynamic investors" in place of: "overt or closeted market timers."
If our house held 10 etf or index funds, we would still attempt (over time periods) to adjust the mix as we viewed market turns and moves; relative to own risk/reward profile.
One may suppose that attempting to further manage our portfolios among active managed funds may add another layer of "meddling". Perhaps.....
IMO, the mix of index or active managed funds is the basis for some decision making. If one has all etf/index funds; then you may want to freely play with these holdings, as you and the markets dictate. If a 50/50 mix of active and passive; perhaps (although always watching) let the active folks who have a nominally decent track record continue their forward march and then play (if one can't shake the fix) with the passive areas.
For those so inclined to the observation of allocation mix; the above does not include this most personal decision area.
I'll stand next to you (Market Timers Anonymous) to profess that this house does meddle from time to time with the holdings in the portfolio. The critical part of this is that we realize the circumstance. The danger zone may be for those who do meddle too much and don't recognize the event for what it may signify.
Hey, gotta go push around some more new snow.
Take care,
Catch
From your response "He postulates an active fund cost of 2.5 % over the entire timeframe such that the investor only receives 5.5 % annual return from an equity marketplace that produces an annual 8.0 % return.
I'm no expert (and also short on time today) .... but that 2.5% figure strikes me as a very large gap in performance. It may well represent some kind of "average" (which includes those herded into front loaded funds). But, geez, those who read the board or follow funds closely ought to be able to do better than that in their selection of actively managed funds and, I think in many cases, outdistance the indexes over shorter time frames.
This is not to refute what I think is the underlying point in all this that over VERY long periods of time, indexes will outperform the aggregate of all actively managed funds. Nonetheless, I think most of us would agree that for certain investors in certain phases of their investing career, actively managed funds can offer some advantages. Regards
Hi Hank,
Thank you for your cogent comments.
I completely agree that averages can be misleading, especially when taken out of context and/or when not augmented with other statistical inputs like timeframe, population surveyed, and dispersion measures.
Actively managed mutual funds can contribute excess returns to a portfolio cobbled together and diligently monitored by a well informed, experienced, committed, and nimble individual investor. All this takes time.
One overarching secret to successful investing is that no single secret exists that applies to all personal situations and/or market circumstances for all time. Change happens.
Although these characteristics may appear to conflict, I suspect that both patience and flexibility are necessary traits. These are not mutually exclusive personal qualities.
Best Wishes.