Difference between revisions of "Bogleheads® investment philosophy for non-US investors"

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(More tidying and wordsmithing, lots more still to do.)
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'''[[The Bogleheads® | The Bogleheads<sup>®</sup>]]''' follow a small number of simple investment principles that have been shown over time to produce risk-adjusted returns far greater than those achieved by the average investor. Many of these ideas are distilled from Nobel prize-winning financial economics research on topics like [http://en.wikipedia.org/wiki/Modern_portfolio_theory Modern Portfolio Theory] and the [[CAPM - Capital Asset Pricing Model | Capital Asset Pricing Model]]. But they are very easy to understand and to implement, and they work. In fact, the basis of all of these principles is the idea that successful investing is not a complicated process, and can be accomplished by anyone with a small amount of effort.
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'''[[The Bogleheads® | The Bogleheads<sup>®</sup>]]''' follow a few simple investment principles that have historically produced risk-adjusted returns that are better than the returns of average investors. These principles are the results of Nobel prize-winning research on [http://en.wikipedia.org/wiki/Modern_portfolio_theory Modern Portfolio Theory] and the [[CAPM - Capital Asset Pricing Model | Capital Asset Pricing Model]]. They are however easy to understand and implement, and they work. Using these principles can make it simple to invest successfully. Anyone can do it with a small amount of effort.
  
These ideas come from the investing philosophy of Vanguard-founder [[John Bogle | Jack Bogle]]. They have been further distilled and explained in thousands of posts on the [[Bogleheads | Bogleheads forums]], starting with original contributors [[Taylor Larimore]] and [[Mel Lindauer]]. More advanced concepts were first widely introduced to the Bogleheads community by investing author [[Larry Swedroe]], a tradition that has been carried on by [[Rick Ferri]] among many others.
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The main ideas come from the investing philosophy of Vanguard's founder, [[John Bogle | Jack Bogle]]. They have been distilled and explained in thousands of posts on the [[Bogleheads | Bogleheads forums]], starting with original contributors [[Taylor Larimore]] and [[Mel Lindauer]]. And investing authors [[Larry Swedroe]], [[Rick Ferri]], and others have introduced more advanced concepts.
  
Although these ideas originate in the US, many of them can be applied to investors worldwide. The general principles, such as cutting costs and using any tax-advantaged accounts that may be available to you, are likely to be valid no matter where you live. This wiki article provides ideas about how you can start to apply these principles to your own investing.
+
Although these ideas originate in the US, investors worldwide can use many of them. The general principles, such as cutting costs and using any tax-advantaged accounts that may be available to you, are likely to be valid no matter where you live. This wiki article provides ideas about how you can start to apply these principles to your own investing.
  
 
==Develop a workable plan ==
 
==Develop a workable plan ==
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There may be specific guidelines in your country, for which accounts you should fund and in what order. But always remember, you first need to save the money.  Saving regularly is more important than investment selection when starting this lifelong process.
 
There may be specific guidelines in your country, for which accounts you should fund and in what order. But always remember, you first need to save the money.  Saving regularly is more important than investment selection when starting this lifelong process.
 
<br style="clear: both" />
 
  
 
== Never bear too much or too little risk ==
 
== Never bear too much or too little risk ==
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[[Bond basics | Bonds]] are a promise to pay back a loan of money on a pre-set schedule.  Bonds do not produce the same expected high returns that stocks do, but they are much less volatile.  The way to get reasonable growth without stomach-churning drops is to hold a mix of stocks and bonds.
 
[[Bond basics | Bonds]] are a promise to pay back a loan of money on a pre-set schedule.  Bonds do not produce the same expected high returns that stocks do, but they are much less volatile.  The way to get reasonable growth without stomach-churning drops is to hold a mix of stocks and bonds.
  
How much in bonds? This is the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take [[Risk and return: an introduction| risk]].  The more risk you can handle, the less bonds you need. When you are young, your prime earning years lie ahead, and it will be decades before you need to access the money. So, higher stock allocations may be suitable since big drops in stock prices will not hurt as long as you do not flee the market. [[John Bogle]] advises that "as we age, we usually have (1) more wealth to protect, (2) less time to recoup severe losses, (3) greater need for income, and (4) perhaps an increased nervousness as markets jump around. All four of these factors suggest more bonds as we age." <ref name="Bogle"> John Bogle, ''Common Sense on Mutuals Funds,'' (2010) pp.87-88</ref>  
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How much in bonds? This is the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take [[Risk and return: an introduction| risk]].  The more risk you can handle, the less bonds you need. When you are young, your prime earning years lie ahead, and it will be decades before you need to access the money. So, higher stock allocations may be suitable since big drops in stock prices will not hurt as long as you do not flee the market. [[John Bogle]] advises that "as we age, we usually have (1) more wealth to protect, (2) less time to recoup severe losses, (3) greater need for income, and (4) perhaps an increased nervousness as markets jump around. All four of these factors suggest more bonds as we age."<ref name="Bogle"> John Bogle, ''Common Sense on Mutuals Funds,'' (2010) pp.87-88</ref>  
  
Although your exact asset allocation should depend on your goals for the money, some ''rules of thumb'' exist to guide your decision. A rule of thumb is just: (1) a method of procedure based on experience and common sense ; (2) a general principle regarded as roughly correct but not intended to be scientifically accurate". <ref> Merriam-Webster, [http://www.merriam-webster.com/dictionary/rule%20of%20thumb "rule of thumb"] </ref> . Any rule of thumb is only a starting point for decision making, not the end.
+
Although your exact asset allocation should depend on your goals for the money, some ''rules of thumb'' exist to guide your decision. A rule of thumb is just: "(1) a method of procedure based on experience and common sense ; (2) a general principle regarded as roughly correct but not intended to be scientifically accurate".<ref> Merriam-Webster, [http://www.merriam-webster.com/dictionary/rule%20of%20thumb "rule of thumb"] </ref> Any rule of thumb is only a starting point for decision making, not the end.
  
Consider Benjamin Graham's <ref>[http://en.wikipedia.org/wiki/Benjamin_Graham Benjamin Graham], wikipedia </ref> timeless advice:
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Consider Benjamin Graham's<ref>[http://en.wikipedia.org/wiki/Benjamin_Graham Benjamin Graham], wikipedia </ref> timeless advice:
{{quotation|We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of 75% to 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums. <ref>''The Intelligent Investor,'' p. 93 of the 2003 edition annotated by Jason Zweig, Collins Business, ISBN 978-0060555665</ref>}}
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{{quotation|We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of 75% to 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.<ref>''The Intelligent Investor,'' p. 93 of the 2003 edition annotated by Jason Zweig, Collins Business, ISBN 978-0060555665</ref>}}
  
[[John Bogle]] recommends "roughly your age in bonds"; for instance, if you are 45, 45% of your portfolio should be in high-quality bonds. Mr. Bogle describes the idea as just "a crude starting point" which "[c]learly . . .must be adjusted to reflect an investor's objectives, risk tolerance, and overall financial position". Bogle also suggests that, during the retirement distribution phase, you include as a bond-like component of your wealth and asset allocation the value of any future pension and Social Security payment you expect to receive. <ref name="Bogle"/>
+
[[John Bogle]] recommends "roughly your age in bonds"; for instance, if you are 45, 45% of your portfolio should be in high-quality bonds. Mr. Bogle describes the idea as just "a crude starting point" which "[c]learly . . .must be adjusted to reflect an investor's objectives, risk tolerance, and overall financial position". Bogle also suggests that, during the retirement distribution phase, you include as a bond-like component of your wealth and asset allocation the value of any future pension and Social Security payment you expect to receive.<ref name="Bogle"/>
  
"Age in bonds" and its variants, (age - 10) or (age - 20), are only crude starting points to be adjusted for the investor's circumstances; a key circumstance being the presence or absence of a pension, which would change ones willingness or need to take risk. Some Bogleheads do not add pensions and Social Security to their asset allocation of bond holdings. <ref>{{Forum post|t=99826|p=1445023 |title=Wiki: Asset Allocation - Update "Age in Bonds"? }} direct link to post.</ref>
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"Age in bonds" and its variants, (age - 10) or (age - 20), are only crude starting points to be adjusted for the investor's circumstances; a key circumstance being the presence or absence of a pension, which would change ones willingness or need to take risk. Some Bogleheads do not add pensions and Social Security to their asset allocation of bond holdings.<ref>{{Forum post|t=99826|p=1445023 |title=Wiki: Asset Allocation - Update "Age in Bonds"? }} direct link to post.</ref>
  
 
It is easy to underestimate risk and to overestimate your tolerance for risk. Many people found out the hard way after the crash of 2008. Those people learned too late they should have been holding more bonds, so you should think carefully before choosing an asset allocation with high stock market allocations. If you have not been through a major market downturn before, it is hard to explain how your logical considerations of risk can quickly become [[Behavioral pitfalls|emotional ones.]] There is an entire field of neuroeconomics now developing explaining how mental traits and emotional effects that work well in other areas undermine our ability to deal rationally with markets and investing.<ref group="note"> A popular text exploring the application of neuroscience and finance is Jason Zweig's book,  ''Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich'', Simon & Schuster (August 1, 2007) ISBN 978-0743276689 </ref>
 
It is easy to underestimate risk and to overestimate your tolerance for risk. Many people found out the hard way after the crash of 2008. Those people learned too late they should have been holding more bonds, so you should think carefully before choosing an asset allocation with high stock market allocations. If you have not been through a major market downturn before, it is hard to explain how your logical considerations of risk can quickly become [[Behavioral pitfalls|emotional ones.]] There is an entire field of neuroeconomics now developing explaining how mental traits and emotional effects that work well in other areas undermine our ability to deal rationally with markets and investing.<ref group="note"> A popular text exploring the application of neuroscience and finance is Jason Zweig's book,  ''Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich'', Simon & Schuster (August 1, 2007) ISBN 978-0743276689 </ref>
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== Never try to time the market ==
 
== Never try to time the market ==
*''[[Video:Bogleheads® investment philosophy#Never try to time the market (Rule #5)| Watch the video]]''
 
 
 
There is a [[US mutual fund performance studies|large amount of US research]] showing that typical US mutual fund investors actually perform far worse than the mutual funds they invest in because they tend to buy after a fund has done well and tend to sell what they own when it has done poorly.  [[US mutual fund performance studies#Timing|Studies on timing]] using returns data show no evidence of positive timing. The vast majority of investors earn less than the market due to two common timing mistakes: buying yesterday's top performers, and letting your emotions cause you to attempt to predict the direction of the stock market. This behaviour of buy high, sell low is guaranteed to produce poor results.  
 
There is a [[US mutual fund performance studies|large amount of US research]] showing that typical US mutual fund investors actually perform far worse than the mutual funds they invest in because they tend to buy after a fund has done well and tend to sell what they own when it has done poorly.  [[US mutual fund performance studies#Timing|Studies on timing]] using returns data show no evidence of positive timing. The vast majority of investors earn less than the market due to two common timing mistakes: buying yesterday's top performers, and letting your emotions cause you to attempt to predict the direction of the stock market. This behaviour of buy high, sell low is guaranteed to produce poor results.  
  
Instead, Bogleheads create a good plan and then stick with it, which consistently produces good outcomes over the long term. <ref group="note"> John Bogle, in ''The Little Book of COMMON SENSE INVESTING,''  (2007), p.51, reports that over the twenty-five years between 1982 - 2007 the stock market index fund was providing an annual return of 12.3 percent while  the average equity fund was earning an annual return of 10.0 percent. Meanwhile, the average fund investor was earning only 7.3 percent a year. <br> Ilia D. Dichev examined investor dollar weighted returns and found an annual difference of 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and an average 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. Dichev, Ilia D., December 2004) ''[http://ssrn.com/abstract=544142 What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns]''; SSRN<br>
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Instead, Bogleheads create a good plan and then stick with it, which consistently produces good outcomes over the long term.<ref group="note"> John Bogle, in ''The Little Book of COMMON SENSE INVESTING,''  (2007), p.51, reports that over the twenty-five years between 1982 - 2007 the stock market index fund was providing an annual return of 12.3 percent while  the average equity fund was earning an annual return of 10.0 percent. Meanwhile, the average fund investor was earning only 7.3 percent a year. <br> Ilia D. Dichev examined investor dollar weighted returns and found an annual difference of 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and an average 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. Dichev, Ilia D., December 2004) ''[http://ssrn.com/abstract=544142 What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns]''; SSRN<br>
 
For a discussion of additional studies of investor performance, see our "unofficial blog" treatment of this Bogleheads principle: {{cite web|url=https://blbarnitz4.wordpress.com/2014/09/18/the-evidence-against-market-timing/|title=The evidence against market timing|publisher=Financial Page|date=September 18, 2014|accessdate=21 March 2016}}</ref>
 
For a discussion of additional studies of investor performance, see our "unofficial blog" treatment of this Bogleheads principle: {{cite web|url=https://blbarnitz4.wordpress.com/2014/09/18/the-evidence-against-market-timing/|title=The evidence against market timing|publisher=Financial Page|date=September 18, 2014|accessdate=21 March 2016}}</ref>
  
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{{Main|Expense ratios|Mutual funds and fees}}
 
{{Main|Expense ratios|Mutual funds and fees}}
  
[[File:Annual Return - Fee Impact.png|right|thumb|450px| Caption| Figure 2. Reducing Expenses by 1% Per Year <ref group="note"> Results are simulated. The saving phase simulates a participant with a salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25, increasing by 0.5% per year to a maximum of 10% and with a 50% company matching contribution up to the first 6% of salary. In retirement, $63,750 (75% of final salary) is deducted at the beginning of each year. The orange-shaded area shows ending savings with an after cost investment return of 9% assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. Inflation is assumed to be a constant 3%. The gray-shaded area assumes 1% greater return each year due to reducing the costs of investment by 1%. All amounts are in present-day dollars. Source: [http://www.dol.gov/ebsa/pdf/TDFSupp1.pdf AllianceBernstein], as presented to the [http://www.dol.gov/ebsa/regs/cmt-targetdatefundshearing.html DOL/SEC Hearing On Target Date Funds And Similar Investment Options]. A spreadsheet is available on Google Drive: [https://drive.google.com/file/d/1fQP7dvo5IPxnnVquzNWB3fOJjEuD283V/view?usp=sharing Effect of investment expenses]</ref>]]
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[[File:Annual Return - Fee Impact.png|right|thumb|450px| Caption| Figure 2. Reducing Expenses by 1% Per Year<ref group="note"> Results are simulated. The saving phase simulates a participant with a salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25, increasing by 0.5% per year to a maximum of 10% and with a 50% company matching contribution up to the first 6% of salary. In retirement, $63,750 (75% of final salary) is deducted at the beginning of each year. The orange-shaded area shows ending savings with an after cost investment return of 9% assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. Inflation is assumed to be a constant 3%. The gray-shaded area assumes 1% greater return each year due to reducing the costs of investment by 1%. All amounts are in present-day dollars. Source: [http://www.dol.gov/ebsa/pdf/TDFSupp1.pdf AllianceBernstein], as presented to the [http://www.dol.gov/ebsa/regs/cmt-targetdatefundshearing.html DOL/SEC Hearing On Target Date Funds And Similar Investment Options]. A spreadsheet is available on Google Drive: [https://drive.google.com/file/d/1fQP7dvo5IPxnnVquzNWB3fOJjEuD283V/view?usp=sharing Effect of investment expenses]</ref>]]
  
 
The difference between an [[Expense ratios | expense ratio]] of 0.15% and 1.5% might not seem like much, but the effect of the compounding over an investing lifetime is enormous. After 30 years, a fund with a 1.5% expense ratio will provide an investor with several hundred thousand dollars less for retirement than a 0.15% index fund with the same growth.<ref>{{cite book|author=Bogle John|date=January/February 2014|title=The Arithmetic of “All-In” Investment Expenses|url=http://johncbogle.com/wordpress/wp-content/uploads/2010/04/FAJ-All-In-Investment-Expenses-Jan-Feb-2014.pdf|location=Financial Analysts Journal Volume 70 (1)|publisher=CFA Institute|pages=}}</ref> And remember that most managed funds actually underperform index funds.  Costs matter, and investors need returns compounding for their own benefit, not the benefit of fund companies who skim unnecessary fees off the top. Figure 2. is an example showing that 1% of additional costs will reduce available retirement funds by 10 years.
 
The difference between an [[Expense ratios | expense ratio]] of 0.15% and 1.5% might not seem like much, but the effect of the compounding over an investing lifetime is enormous. After 30 years, a fund with a 1.5% expense ratio will provide an investor with several hundred thousand dollars less for retirement than a 0.15% index fund with the same growth.<ref>{{cite book|author=Bogle John|date=January/February 2014|title=The Arithmetic of “All-In” Investment Expenses|url=http://johncbogle.com/wordpress/wp-content/uploads/2010/04/FAJ-All-In-Investment-Expenses-Jan-Feb-2014.pdf|location=Financial Analysts Journal Volume 70 (1)|publisher=CFA Institute|pages=}}</ref> And remember that most managed funds actually underperform index funds.  Costs matter, and investors need returns compounding for their own benefit, not the benefit of fund companies who skim unnecessary fees off the top. Figure 2. is an example showing that 1% of additional costs will reduce available retirement funds by 10 years.

Revision as of 03:36, 23 May 2020

The Bogleheads® follow a few simple investment principles that have historically produced risk-adjusted returns that are better than the returns of average investors. These principles are the results of Nobel prize-winning research on Modern Portfolio Theory and the Capital Asset Pricing Model. They are however easy to understand and implement, and they work. Using these principles can make it simple to invest successfully. Anyone can do it with a small amount of effort.

The main ideas come from the investing philosophy of Vanguard's founder, Jack Bogle. They have been distilled and explained in thousands of posts on the Bogleheads forums, starting with original contributors Taylor Larimore and Mel Lindauer. And investing authors Larry Swedroe, Rick Ferri, and others have introduced more advanced concepts.

Although these ideas originate in the US, investors worldwide can use many of them. The general principles, such as cutting costs and using any tax-advantaged accounts that may be available to you, are likely to be valid no matter where you live. This wiki article provides ideas about how you can start to apply these principles to your own investing.

Develop a workable plan

The Bogleheads approach to developing a workable financial plan is to first establish a sound financial lifestyle.

Develop a sensible household budget. This is one that provides for needed expenditures, discretionary pleasures and savings for large items like home purchase and higher education for dependants, as well as savings for long term retirement planning.

  • Avoid bad debt; if you have such debt, pay off those balances first.
  • Perhaps the most important idea underlying the Bogleheads approach to investing is recognising you need to save a significant portion of income every month to have enough money for a comfortable retirement. There is no substitute for spending less than you earn. Live below your means. If you don't save enough, no amount of financial trickery will provide the returns needed for a comfortable retirement.

Next, after establishing your sound financial lifestyle and you start investing for the future, many believe it is valuable to put a simple plan in writing. Relax! Of course you can’t know the future! But it will serve you to imagine one scenario. The enemy of a good plan is the search for a perfect plan. Make assumptions, and then change them when you get better ideas or better information. The goal is to enable these possibilities. Putting your plan in writing will help give you the discipline to “stay the course”.

Invest early and often

Fig.1. Returns compounded at 8% per annum

Once you establish a regular savings pattern, you can begin the process of accumulating financial wealth. How much saving is enough? Twenty percent of income is a good baseline number. If you plan to retire before age 65 or plan to leave significant assets to charity or children, you probably need to save even more.[1] The reason starting a regular savings plan early in life is important is that compounding of investment returns can be magnified over a longer period. Figure 1. demonstrates the benefit of starting early.

The best way to save money is to arrange automatic deductions from your salary. If your employer has a pension plan, they may already provide this convenience. When you invest, consider using a fund company able to automatically deduct money from your bank account the day after pay day. This concept, described as "paying yourself first," goes a long way towards establishing and reinforcing reasonable spending habits.

There may be specific guidelines in your country, for which accounts you should fund and in what order. But always remember, you first need to save the money. Saving regularly is more important than investment selection when starting this lifelong process.

Never bear too much or too little risk

To know whether an asset allocation is right for your risk tolerance, you need to be brutally honest with yourself as you try to answer the question, "Will I sell during the next bear market?, which is very hard to accurately assess before you have already gone through a bear market.

Owning stocks is necessary to get the expected return needed to accumulate funds for retirement. Stocks provide us with a share of the profits generated by publicly owned companies in the economy. But in exchange for the hope of high return, stocks are extremely volatile and risky. Many investors learned how risky stocks can be in 2008 when they fell 50% from their previous highs. Over time, stock prices roughly follow the trend of the economy, which is to grow. But prices can stagnate or decline for decade-long periods. This is why having an allocation to bonds is a necessary element of asset allocation.[2]

Bonds are a promise to pay back a loan of money on a pre-set schedule. Bonds do not produce the same expected high returns that stocks do, but they are much less volatile. The way to get reasonable growth without stomach-churning drops is to hold a mix of stocks and bonds.

How much in bonds? This is the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk. The more risk you can handle, the less bonds you need. When you are young, your prime earning years lie ahead, and it will be decades before you need to access the money. So, higher stock allocations may be suitable since big drops in stock prices will not hurt as long as you do not flee the market. John Bogle advises that "as we age, we usually have (1) more wealth to protect, (2) less time to recoup severe losses, (3) greater need for income, and (4) perhaps an increased nervousness as markets jump around. All four of these factors suggest more bonds as we age."[3]

Although your exact asset allocation should depend on your goals for the money, some rules of thumb exist to guide your decision. A rule of thumb is just: "(1) a method of procedure based on experience and common sense ; (2) a general principle regarded as roughly correct but not intended to be scientifically accurate".[4] Any rule of thumb is only a starting point for decision making, not the end.

Consider Benjamin Graham's[5] timeless advice:

We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of 75% to 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.[6]

John Bogle recommends "roughly your age in bonds"; for instance, if you are 45, 45% of your portfolio should be in high-quality bonds. Mr. Bogle describes the idea as just "a crude starting point" which "[c]learly . . .must be adjusted to reflect an investor's objectives, risk tolerance, and overall financial position". Bogle also suggests that, during the retirement distribution phase, you include as a bond-like component of your wealth and asset allocation the value of any future pension and Social Security payment you expect to receive.[3]

"Age in bonds" and its variants, (age - 10) or (age - 20), are only crude starting points to be adjusted for the investor's circumstances; a key circumstance being the presence or absence of a pension, which would change ones willingness or need to take risk. Some Bogleheads do not add pensions and Social Security to their asset allocation of bond holdings.[7]

It is easy to underestimate risk and to overestimate your tolerance for risk. Many people found out the hard way after the crash of 2008. Those people learned too late they should have been holding more bonds, so you should think carefully before choosing an asset allocation with high stock market allocations. If you have not been through a major market downturn before, it is hard to explain how your logical considerations of risk can quickly become emotional ones. There is an entire field of neuroeconomics now developing explaining how mental traits and emotional effects that work well in other areas undermine our ability to deal rationally with markets and investing.[note 1]

Bogleheads like to own bond funds instead of individual bonds for convenience and diversification. The high number of different bonds in bond funds let you ignore the risk of any one bond defaulting. Interest rate risk can be managed if you select funds with short and intermediate-term duration, while default risk can be managed by selecting funds with high credit ratings. The central idea here is that your bond holdings are for safety, to reduce violent up and down swings in overall portfolio value. Bogleheads tend to take risks on the equity side, not the bond side.

The goal is to select an asset allocation that lets you sleep at night, and avoid the destructive urge to sell out in a panic the next time the market plummets; then having to agonise over when its a "good time' to get back in. This leads to selling low and buying high, the exact opposite of prudent investing.

Bogleheads typically divide bond allocations between just two categories: nominal bonds, and inflation protected bonds. The use of a fund of inflation protected bonds provides additional diversification as well as inflation protection.[note 2] Particularly when using inflation protected bonds, it is important to consider that you want protection from your own country's inflation rate. This argues for using purely domestic bonds for at least this portion of your investments.

Diversify

Rather than trying to pick the specific stocks or sectors of the market that may outperform in the future, Bogleheads buy funds that are widely diversified, or even approximate the whole market.[8] This guarantees they will receive the average return of all investors. Being average sounds bad, but it is actually a great thing. This is because most investors perform worse than average after taking into account the high fees they msy pay for actively managed funds. Studies of manager performance in the US indicate that, before costs, managers, on average, possess stock selection skill, but actual performance is insufficient to overcome the costs of management. In addition, while there is evidence of persistence of poor performance, there is no evidence of persistence of outperformance. Funds that outperform one year tend to underperform in the next. And in the real world, investors pay high fees on managed funds. That means more than half of those actively managed funds usually underperform index funds over the long haul.

Never try to time the market

There is a large amount of US research showing that typical US mutual fund investors actually perform far worse than the mutual funds they invest in because they tend to buy after a fund has done well and tend to sell what they own when it has done poorly. Studies on timing using returns data show no evidence of positive timing. The vast majority of investors earn less than the market due to two common timing mistakes: buying yesterday's top performers, and letting your emotions cause you to attempt to predict the direction of the stock market. This behaviour of buy high, sell low is guaranteed to produce poor results.

Instead, Bogleheads create a good plan and then stick with it, which consistently produces good outcomes over the long term.[note 3]

Use index funds when possible

The best and lowest cost way to buy the whole stock market is with index funds (either through traditional mutual funds or ETFs).

For a typical non-US investor, a single global ("all-world") stock fund or ETF such as Vanguard VWRD, is the simplest way to own a fully diversified stock portfolio. VWRD is Vanguard's EU domiciled all-world stock ETF. Non-US investors need to pay attention to several tax issues that arise from directly holding US domiciled funds or ETFs, or US stocks.

Keep costs low

Figure 2. Reducing Expenses by 1% Per Year[note 4]

The difference between an expense ratio of 0.15% and 1.5% might not seem like much, but the effect of the compounding over an investing lifetime is enormous. After 30 years, a fund with a 1.5% expense ratio will provide an investor with several hundred thousand dollars less for retirement than a 0.15% index fund with the same growth.[9] And remember that most managed funds actually underperform index funds. Costs matter, and investors need returns compounding for their own benefit, not the benefit of fund companies who skim unnecessary fees off the top. Figure 2. is an example showing that 1% of additional costs will reduce available retirement funds by 10 years.

Some employer pension plans may not offer any index funds. In this case, Bogleheads generally look for the largest, most diversified funds with the lowest fees. These "closet index funds" tend to perform relatively like index funds (although with higher fees). If you need to find the "least-bad" funds available in your own employer pension, start by looking for the funds with the lowest expense ratios.

Minimize taxes

Perhaps the reason that Bogleheads focus carefully on tax efficiency is that no one controls how equity markets might perform in a given year. Rather than obsessing over the unknowable, you should focus on areas where your decisions can save money: by preserving money for retirement what would otherwise go to governments, either your own or foreign ones.

The most important rule for tax efficiency is to take full advantage of any tax-advantaged accounts in your country. These allow your money to grow, using the magic of compound interest, without a portion being removed every year to pay taxes. Many investors have large enough tax-advantaged accounts to hold all of their retirement savings, and so never need to worry about tax efficient placement.

But for those who also have taxable accounts, look carefully at the tax efficiency of each holding. Some asset classes may be much more tax-efficient for you than others. You would usually aim to place tax-inefficient assets into tax-advantaged accounts, wherever possible.

The key thing to remember about tax efficiency is that tax-efficient asset placement matters. The same funds may produce considerably more for your retirement if you place them in a tax efficient manner.

Invest with simplicity

Simplicity: A three fund portfolio

Simplicity is the master key to financial success. When there are multiple solutions to a problem, choose the simplest one.

— Investing With Simplicity, John Bogle[10]

It is not necessary to own many funds to achieve effective diversification. A single all-world stock market index fund contains thousands of stocks. Similarly, a global or total bond market index fund contains thousands of bonds of various types and maturities. It is entirely possible to build a highly effective portofolio with just two or three funds.

A simple portfolio has many advantages. It almost always lowers costs (including taxes), makes analysis easier, simplifies rebalancing, simplifies tax-preparation, reduces paper-work and record-keeping, and enables caregivers and heirs to easily take-over the portfolio when necessary. Best of all, a simple portfolio allows you to spend more time with family and friends, and less time managing your finances.

Some Bogleheads use more than three or four funds in their portfolios, but as with all investment decisions, you should be aware of the risks and costs before doing so.

Stay the course

This is perhaps the most challenging part of Boglehead investing, but is essential to its success. Bogleheads adopt a reasonable investment plan and then stay the course. When index funds were dramatically outperforming all the alternatives in the 1990's, this advice was easy to follow. But with the crash of 2008, many investors panicked, or at least wavered in their commitment to buy, hold, and rebalance investing. Bogleheads realize that in exchange for the high returns that stocks produce over time, the equity markets are enormously volatile. After big drops, it can be very difficult to continue to follow your pre-set plan. Even during normal markets there are always distractions, such as attractive new asset classes that have recently outperformed, or fancy alternative investment vehicles, such as hedge funds.

Bogleheads strive not to be distracted, and strive not to waver.

Create an asset allocation that includes bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance when needed. This balanced approach will help you to stay the course. Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels. (Investors generally want to increase bond holdings slightly every year, such as by setting the percentage of bonds "to your age in bonds".) Although making only that one change every year takes discipline, it is also an enormous relief to be able to tune out the endless chatter of when and what to buy and sell.

Conclusion

In summary, a Bogleheads investor tends to (1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.

One of the wonderful things about Boglehead investing is that it generally only requires a part of a day to set up, and then about an hour a year of effort to rebalance. Beyond that, there is no need to watch the markets or follow financial news. Even better, it works. Although Bogleheads investing may seem strangely simple, it is based on decades of comprehensive research showing that buying and holding the whole market consistently outperforms many of the alternatives.

In addition to learning the details of Bogleheads investing from this wiki, we urge you to visit the Bogleheads forum. Nearly everyone appreciates the shared commitment to implementing financial plans that enable us to accomplish our life goals.

See also

Notes

  1. A popular text exploring the application of neuroscience and finance is Jason Zweig's book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, Simon & Schuster (August 1, 2007) ISBN 978-0743276689
  2. Bogleheads' Guide To Investing, John Wiley & Sons, Inc., 2007, page 103.
  3. John Bogle, in The Little Book of COMMON SENSE INVESTING, (2007), p.51, reports that over the twenty-five years between 1982 - 2007 the stock market index fund was providing an annual return of 12.3 percent while the average equity fund was earning an annual return of 10.0 percent. Meanwhile, the average fund investor was earning only 7.3 percent a year.
    Ilia D. Dichev examined investor dollar weighted returns and found an annual difference of 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and an average 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. Dichev, Ilia D., December 2004) What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns; SSRN
    For a discussion of additional studies of investor performance, see our "unofficial blog" treatment of this Bogleheads principle: "The evidence against market timing". Financial Page. September 18, 2014. https://blbarnitz4.wordpress.com/2014/09/18/the-evidence-against-market-timing/. Retrieved 21 March 2016.
  4. Results are simulated. The saving phase simulates a participant with a salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25, increasing by 0.5% per year to a maximum of 10% and with a 50% company matching contribution up to the first 6% of salary. In retirement, $63,750 (75% of final salary) is deducted at the beginning of each year. The orange-shaded area shows ending savings with an after cost investment return of 9% assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. Inflation is assumed to be a constant 3%. The gray-shaded area assumes 1% greater return each year due to reducing the costs of investment by 1%. All amounts are in present-day dollars. Source: AllianceBernstein, as presented to the DOL/SEC Hearing On Target Date Funds And Similar Investment Options. A spreadsheet is available on Google Drive: Effect of investment expenses

References

  1. Pfau, Wade D. (May 2011). Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle. Journal of Financial Planners. https://www.onefpa.org/journal/Pages/Safe%20Savings%20Rates%20A%20New%20Approach%20to%20Retirement%20Planning%20over.aspx.
  2. Davis, Joseph, Ph.D. and Piquet, Daniel, Recessions and balanced portfolio returns, October, 2011, Vanguard Institutional
  3. 3.0 3.1 John Bogle, Common Sense on Mutuals Funds, (2010) pp.87-88
  4. Merriam-Webster, "rule of thumb"
  5. Benjamin Graham, wikipedia
  6. The Intelligent Investor, p. 93 of the 2003 edition annotated by Jason Zweig, Collins Business, ISBN 978-0060555665
  7. Bogleheads® forum post: Wiki: Asset Allocation - Update "Age in Bonds"? direct link to post.
  8. John Norstad, The Arguments for Investing in Total Markets
  9. Bogle John (January/February 2014). The Arithmetic of “All-In” Investment Expenses. Financial Analysts Journal Volume 70 (1): CFA Institute. http://johncbogle.com/wordpress/wp-content/uploads/2010/04/FAJ-All-In-Investment-Expenses-Jan-Feb-2014.pdf.
  10. Investing With Simplicity

External links