John Bogle: “The stock market is a giant distraction.”

by Mike Holman

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This guest post is written by Mike from the The Oblivious Investor.   This blog has been around for a few months and is very investment oriented (but not too techy) so I would recommend you check it out (I’m a regular reader).

For me, the above quote was enough to make Bogle’s Little Book of Common Sense Investing worth the read.

In just 7 words, Bogle manages to:

•    Provide an insightful piece of investing wisdom.
•    Make you question your assumptions.
•    Offend an entire industry.

So what is Bogle saying here? I think he’s making two distinct points. First, he’s making a statement about intelligent investing. Second, he’s offering a rather pointed criticism of the financial services industry.

Passive investing is a good thing

As to investment strategy, Bogle (as usual) is suggesting a system of passive investing. We can’t predict whether the market is about to go up or about to go down, and attempting to do so will only harm our performance. Similarly, attempting to pick individual stocks is unlikely to prove successful.

So if we stand to gain nothing by timing the market or picking stocks, what’s the point in watching the market? There is no point. All it can do it tempt us toward poor decisions. Better to ignore it.

Financial service is expensive

Bogle’s second point is one about the financial services industry in general, and it’s a bit less obvious. At their most fundamental level, financial markets exist to connect providers of capital (investors) with users of capital (businesses). Without a doubt, this is a valuable service.

However, in recent decades, the financial services industry has convinced us that it performs another service as well: Enhancement of investment returns. This is, however, impossible by definition.

There’s no way that investors—as a group—can earn more than the total earnings of the businesses in which they invest. The total return earned by investors must be equal to the return earned by the businesses in our economy, minus the costs of investing.

We can therefore conclude that, rather than enhancing investor returns, the financial services industry must in fact be reducing investor returns by the sum total of all the fees that they charge us. Sadly, these costs of investing—mutual fund sales loads, fund operating expenses, brokerage fees, etc.—now total in the hundreds of billions of dollars per year.

Conclusion – ignore the market

I think Bogle’s reference to the stock market as a “giant distraction” is his way of telling the reader precisely how much value he sees in the services offered by most firms in the industry.

Takeaway lessons for us:
1.    Turn off BNN and CNBC, and
2.    Do your best to minimize the investment costs you pay.

About the Author:
Mike writes at The Oblivious Investor, where he regularly reminds readers to ignore the noise of the market. If you like this post, subscribe to his blog to read more.

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{ 8 comments… read them below or add one }

1 Mr. Cheap

Interesting post (and a great quote)!

2 Mike P

Thanks, Mr. Cheap. It’s certainly one of my favorite investing quotes. Such a powerful statement with so few words.

3 john

I agree except I still watch BNN and CNBC for fun.

4 Four Pillars

Thanks for the great guest post Mike – I really enjoyed it.

5 Jordan

Let me start by saying I’m a passive indexer. One idea I have trouble with is you can’t beat the market on average.

Yes when you add every investment and divide by investors then on average the market return is the average for everyone.

But if there are so many poor investors out there who under perform the market, people who try to time the market and fail, take on too much risk, buy the next hot stock/sector after it takes off, sell when there is a downturn, etc, etc. Basically just have a history of doing the wrong thing.

I think it’s safe to say on average that group will always under perform the average of the market. But doesn’t that mean if you *dont* follow those bad behaviors, or do something else that there should be a way to gain the return they give up? If not who gets it, professionally managed institution money?

The thing that comes to my mind for the average investor is the fundamental index concept, but I’m not sure. The problem is in theory it has an excellent track record of beating the index without adding risk. But in the short term reality the actual ETFs haven’t really shown over performance.

Curious if anyone has any thoughts on this?

6 Mike P

Hi Jordan.

That’s a great question. Something I ponder rather frequently in fact.

After all, you’re absolutely right: If there are people underperforming, there must be people overperforming.

One thing I’d caution against, though, is the idea that for every person who underperforms, there must be a person who outperforms.

Instead, it’s for every dollar that underperforms, there must be a dollar that outperforms.

And with only 34% of equities owned by individual investors, most of the dollars we’re up against are managed by some pretty smart people.

William Bernstein (the author who wrote The Four Pillars of Investing) recently put it this way in Money magazine:

“Remember, when you venture into the markets, you’re competing against Warren Buffett, the giant Yale endowment fund, and a worldwide army of hypercompetitive M.B.A.s who wake up before you do and go to sleep later as well.”

And that is what has lead me to elect a passive investment strategy. Beating the market certainly isn’t impossible. I’ve simply chosen not to bet on it. :)

7 Jordan

@ Mike P

That’s a good point. So maybe that goes back to the “after expenses” part. That maybe you can assume those big institutional investors can over perform the market (due to size and talent), maybe even individual M.B.A.’s but for the average individual investor to have access to the same talent/resources would cost more then they can add in value for the size of our portfolios?

Also is a mutual fund considered to be an institutional investor (since as a whole it could be controlling millions of dollars) that the average investor is competing against? Since most of them also fail to beat the market it seems like there are a lot of under performers leaving profit on the table for someone.

8 Mike P

Jordan:

“for the average individual investor to have access to the same talent/resources would cost more then we can add in value for the size of our portfolios”

Yep. That’s pretty much my thought process here. Well said.

As to the topic of most mutual funds underperforming the market: It’s my understanding that funds tend (on average, and over the long-term) to underperform by an amount roughly equal to their expense ratio.

Or to phrase it differently: Before considering expenses, funds tend (on average) to roughly match the market’s return. As such, I’m not sure how much “profit is left on the table.” (Except for the fund managers themselves, of course. ;) )

Granted, the only data I’ve seen on this recently is from the two John Bogle books I’ve read in the last couple months. So perhaps not the most unbiased source of information.

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