Michael Hanson
Business in Review

Attack of the Indexers!

By, 12/10/2010

Don't Count on It!: Reflections on Investment Illusions, Capitalism, "Mutual" Funds, Indexing, Entrepreneurship, Idealism, and Heroes    John C. Bogle


The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between — William J. Bernstein

I spent the last week or so reading just about everything John Bogle ever published. And man, is that guy cynical about the investing world! The title of his newest book, Don't Count on It! is a mantra, almost self-help guru-ish in its repeated invocation, to be dubious about anyone or anything in investing. The book is a sort of "greatest hits" of speeches and excerpts from Bogle's career. In this, it ebbs and flows—his personal reflections on building the Vanguard funds can be engrossing. But at 603 pages, one wonders about the editing—the book is frustratingly redundant, often repeating whole passages.

Bogle believes investing today is populated with products that overcharge and under-deliver; the system is overrun with marketing and lacks stewardship; and virtually no one can outperform the markets over time. So the best thing to do is get market-like returns via ultra-low cost index funds.

Well, that's certainly a populist view. And a lot of his proclamations (getting rid of quarterly results for public companies, earnings restatements, etc.) go too far. But there's much gold to be mined in Bogle's views too. It's a jungle out there for novice investors: The proliferation of products, not knowing who to trust…it's daunting and folks do get burned. Heck, stock brokers at this point don't even have a fiduciary duty to serve their clients' best interests! And it's at least plausible to argue expenses at many plain-vanilla type mutual funds could be lower. Vanguard, if anything, is simply spectacular at providing the public well-constructed index funds at low cost. (For years, my boss Ken Fisher has railed publically about the shortcomings of mutual funds and the like for many of the same reasons Bogle does.)

But there's a rising tide in the industry countering all this: fee-based separate account management. (Full disclosure: That's what we folks at MarketMinder do.) Registered investment advisers manage clients' accounts separately (by far a more efficient thing than pooled mutual funds), have fiduciary duty to serve their clients' best interests, take compensation as a percentage of assets managed (so there's a big incentive to do well and right by the client), and can in fact long term beat the markets net of fees. I know this because I work for such a place. This simple framework, to my mind, solves most of the stewardship and cost problems Bogle rails against. 

If you can't (or don't want to) find a manager you believe will consistently do those things, indexing can be fine enough. Just one problem: you still must decide on asset allocation (a trickier business than it often seems) and have the guts to stick with the strategy. A passive all-equity strategy went down just as much as the market in 2008. In other words, it's still YOU who must be disciplined and sit tight when the world feels like it might be ending—that might be the toughest thing of all in this business. I, for one, witnessed many die-hard passive investors lose their gumption, sell out, and miss the big rally of 2009—doubly damaging. So, behaviorally, passive investing has its problems.  

Actually, the indexers inadvertently prove one of the most important lessons for active portfolio managers and stock investors generally: At a minimum you want a strategy that captures the baseline long-term return of equities. To do that, you have to be in stocks. Most get this backwards: people fear losses way too much (now is a classic era for that). The simple reality is that, over time, stocks run circles around the hesitant. You can't ease into stocks figuring there will eventually be a lower point to get in. That might feel intuitive after a decade of flat returns, but in practice it fails more than it works. This has been proven statistically over and over, but the investing community consistently turns a deaf ear to it. 

Which brings us to Mr. Bernstein. There's sort of a mutual admiration society between Bogle and Bernstein. You can't read their work interchangeably, but most of it's in the same ballpark. They cite each other often as influences. Bernstein's latest, The Investor's Manifesto, is really an update from his past books, The Four Pillars of Investing and The Intelligent Asset Allocator.  

Bogle righteously emphasizes simplicity in a world of rising complexity. Bernstein says his Manifesto is the simplified version of his views, but a layperson will be befuddled after a few chapters. He seems to mistake brevity (and the book is brief) for complexity of concepts. Statistical explanations of how equity risk premiums are supposed to work, why (to Bernstein's view) small cap stocks are better than large, and so on, will vex neophytes. Mr. Bernstein seems to sense this—which is probably why he argues it's so difficult to outperform the market, so few can do it, and most are best served passively investing in index funds, a la Bogle.

But there's some worthwhile wisdom in there too. Bernstein is one of the few to (rightly) favor being a student of market history and, as such, see that "the more you study market history, the fewer black swans you see." Absolutely correct. And Bernstein interestingly discusses the "narrative" of a company. He advocates knowing the fundamental macro forces really driving share price—a story of the stock that explains why you hold it—instead of toying with the statistical gerrymandering that is valuation and financial statement analysis these days. Bernstein says investors tend to go for the sexy story, the sexy stock (Apple, anyone?), but often miss the companies that are less popular but really drive the economy—your heavy Industrials, Materials, commercial banks, and so on.


Bogle and Bernstein recognize that most folks planning for retirement (or are in it) need a lot of stocks to fight the effects of fees and inflation and achieve any decent return. Yet, they recommend a lot of bonds. This conventional wisdom has always been tough to justify when really scrutinized. It's about as close as investing gets to a physical law (to my mind) that the long-term return on stocks is better than bonds. So, by definition, the more of a lower returning asset you hold, the lower your total expected return. Period. Yes, stocks are more volatile—a feature of the higher expected returns. But if your time horizon is long (which it is for most folks even in retirement), that can be ok. A good adviser, even if they don't call every market environment rightly, should be able to help you navigate those times of rough volatility—not allowing you to get too high when stocks soar, but also not allowing you to panic when they fall a lot. 

In the end, indexing can be a viable and low-cost way to get a well-diversified portfolio. But it doesn't relieve individual investors of decision-making responsibility—no getting around it. For those who don't want the onus, seek the help of a good advisor. Contrary to today's cynicism, there are in fact many fine and responsible stewards who can help build your wealth over time.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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