Bogleheads® investment philosophy for non-US investors
|This page contains details specific to non-US investors. It does not apply to United States (US) investors, or to US citizens and US permanent residents (green card holders) living outside the US.|
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 forum, 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.
When reading the wiki, you will encounter pages written for US investors. Take care not to assume that the details of how to invest as a Boglehead in the US will necessarily apply to your own country. There will probably be large differences between the best actions for US investors and those for investors in your country, in particular around tax and the availability of retirement savings plans. When in doubt, ask on the Bogleheads forum.
Develop a workable plan
The first step to a workable financial plan is establishing a sound financial lifestyle, starting with a sensible household budget. A budget makes sure that you can cover necessary expenditures such as housing, food and clothing, discretionary items such as eating out and holidays, saving for large items like home purchase and higher education for your children, and saving for retirement.
- Avoid bad debt. Typically, this would be any debt with a high interest rate, for example credit card debt. If you have any, pay it off first.
- Understand that you may need to save a significant portion of your income every month to give you enough money for a comfortable retirement. There is no substitute for spending less than you earn. Live below your means. If you do not save enough, your assets will not provide the returns you need for a comfortable retirement.
After establishing your sound financial lifestyle, you can start investing for the future. Writing a simple plan will help. Of course you cannot know the future, but writing a plan will help you shape your ideas. The plan does not need to be perfect, just reasonable. Include assumptions in your plan, but be ready to change them when you get better ideas or better information. The goal is to make this plan a reality. Writing it will help you gain the discipline to do that.
Invest early and often
Once you have a regular savings pattern, you can begin accumulating financial wealth. How much saving is enough? The answer depends heavily on what you are saving for, and how your country supports and taxes investment income. For retirement, 20% of income may be a good starting point, but this will vary widely from person to person and from country to country. However, starting saving early in life is important because investment returns compound over a longer period.
If your employer offers it, one way to save money is to arrange automatic payments into savings from your salary, typically as part of a pension plan. If not, or if you want to save more outside of this plan, try to use a broker that can automatically deduct money from your bank account regularly. This helps to establish and reinforce good spending.
In your country, there may be specific guidelines or recommendations for which accounts you should fund, and in what order. But always remember, you first need to save the money. When you start, saving regularly is more important than your choice of investments.
Never bear too much or too little risk
Your risk tolerance is your ability to stick to an investment plan through difficult financial and market conditions. To know if an asset allocation matches your risk tolerance, ask yourself if you held it, would you sell during the next bear market? This is very hard to answer honestly before you have experienced one.
To give you sufficient money for retirement, you want assets with a decent expected return. This means you need to own stocks. Stocks return a share of the profits generated by publicly owned companies. But although they offer a chance of good returns, stocks are volatile and risky. In 2008, some markets 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 your asset allocation needs to include bonds as well as stocks.
Bonds are a promise to pay back a loan of money on a set schedule. Bonds do not have the expected returns of stocks, but they are much less volatile. A mix of stocks and bonds will produce reasonable growth without frightening drops.
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 sell during the drop. John Bogle wrote:
[A]s 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.
Although your exact asset allocation should depend on your goals for the money, there are a few general guides that you can follow. These are based on practice rather than on theory, and are only a starting point for decision making, not the end.
For example, Benjamin Graham wrote:
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.
Alternatively, John Bogle recommends "roughly your age in bonds". For instance, if you are 45, 45% of your portfolio should be in high-quality bonds. He 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". He also suggests that you should treat any national or state retirement income you might receive as if it is a bond, setting its assumed value appropriately.
This "age in bonds" and its variants, age minus ten years or age minus twenty years, are only approximate starting points. You will probably want to adjust them to fit your circumstances. For example, if you have a guaranteed state or other pension, this changes both your need and your willingness to take risk.
It is easy to underestimate risk and to overestimate your tolerance for risk. In 2008, many people learned too late they should have been holding more bonds. Think carefully before choosing an asset allocation with high stock market allocations. If you have not been through a major market downturn before, your abstract logical considerations of risk can quickly become emotional ones. The developing field of neuroeconomics explains how mental traits and emotional effects that work well in other areas undermine our ability to deal rationally with markets and investing.[note 1]
You should generally 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. You can manage interest rate risk by choosing funds with short and intermediate-term duration, and default risk by choosing funds with high credit ratings. The idea here is for your bond holdings to reduce violent up and down swings in overall portfolio value. You want your risks on the equity side, not the bond side.
Aim 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 worry over when is the time to get back in. This leads to selling low and buying high, the exact opposite of prudent investing.
You may be able to divide your bond allocations between just two categories: nominal bonds, and inflation protected bonds. Inflation protected bonds provide both additional diversification and inflation protection. When using inflation protected bonds, remember that you want protection from your own country's inflation rate. This suggest using purely domestic bonds for at least this portion of your investments.
If domestic bonds are not an option for you, perhaps your country's domestic bond market is limited or unappealing, you can use global bonds instead. You should however probably avoid foreign inflation protected bonds, except where your local currency is pegged to the currency of the bond issuer.
Rather than trying to pick the specific stocks or sectors of the market that may outperform in the future, buy funds that are widely diversified, or even approximate the whole market. This guarantees you will receive the average return of all investors.
Being average sounds bad, but it is actually good. Most investors perform worse than average after taking into account the high fees they pay for actively managed funds. Studies of manager performance in the US indicate that on average, managers may possess stock selection skill, but their extra performance is more than outweighed by their management costs. And while there is evidence of persistent poor performance, there is no evidence of persistent outperformance. Funds that outperform in one year tend to underperform in the next. And investors pay high fees for actively managed funds. As a result, over the long term, more than half of actively managed funds usually underperform index funds.
Never try to time the market
US research shows that typical US mutual fund investors actually perform far worse than the mutual funds they invest in because they buy after a fund has done well and then sell when it has done poorly. Studies on timing using returns data show no evidence of positive timing. Most investors earn less than the market due to two common timing mistakes: buying yesterday's top performers; and letting their emotions lead them to try to predict stock markets.
Instead, you want to create a good plan and then stick with it. This produces consistently good outcomes over the long term.
Use index funds when possible
The best and lowest cost way to buy the whole stock market is with index funds. This can be 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
The difference between a fund fee of 0.15% and 1.5% might not seem like much, but the effect of compounding over an investing lifetime is enormous. After 30 years, a fund with a 1.5% expense ratio will provide an investor with much less money than a 0.15% index fund with the same growth. Remember that most managed funds underperform index funds. Costs matter, and investors need returns compounding for their own benefit, not the benefit of fund companies.
Some employer pension plans may not offer any index funds. If yours does not, look for the largest, most diversified funds with the lowest fees. These will often tend to perform relatively like index funds, although with higher fees. If you need to find the "least-bad" funds in your own employer pension, look for those with the lowest annual costs.
Nobody controls how equity markets might perform in a given year. Rather than worrying about this, focus on areas where your decisions can save money. In particular, do what you can to preserve money for retirement what would otherwise go to governments, either your own or foreign ones.
If your country has an income tax, the most important rule for tax efficiency is to take full advantage of any tax-advantaged accounts it offers. These will allow your money to grow, with compound interest but without a portion being removed every year to pay taxes. Some investors have tax-advantaged accounts large enough to hold all of their 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.
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 is the master key to financial success. When there are multiple solutions to a problem, choose the simplest one.
You do not need to hold many funds to achieve effective diversification. A single all-world stock market index fund contains thousands of stocks. And 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 portfolio 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 paperwork and record-keeping, and enables others such as 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.
You may need to use more than three or four funds in your portfolio, but be aware of the risks and costs before you do this.
Stay the course
This can be the most challenging part of successful investing, but it is essential. Create a reasonable investment plan and then stick to it. When index funds were dramatically outperforming all the alternatives in the 1990's, this advice was easy to follow. But in 2008, many investors panicked, or at least wavered in their commitment to buy, hold, and rebalance investing. Realise that in exchange for the high returns that stocks produce over time, equity markets are enormously volatile. After big drops, it can be very difficult to continue to follow your plan. Even during normal markets there are always distractions, such as attractive new asset classes that have recently outperformed.
Try not to be distracted, and try 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 will help you to stay the course. Once you have set up your portfolio, the only change needed is to occasionally rebalance to bring your stock/bond allocations back to their assigned levels.[note 2] 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.
A Bogleheads investor will
- save a lot,
- select an asset allocation containing both stock and bond asset classes,
- buy low cost, widely diversified funds,
- allocate funds tax-efficiently,
- and stay the course
This generally requires only 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 this 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.
- For more, see 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
- You may want to increase bond holdings slightly every year, such as by setting the percentage of bonds to your "age in bonds".