How to Invest by John Bogle

From John Bogle’s book, “The Little Book of Common Sense Investing”

Key takeaways from John Bogle

“Deep down, I remain absolutely confident that the vast majority of American families would be well served by owning their equity holdings in a Standard & Poor’s 500 Index fund (or a total stock market index fund) and holding their bonds in a total bond market index fund. (Investors in high tax brackets, however, would instead own a very low-cost quasi-index portfolio of high-grade intermediate-term municipal bonds.) To repeat, while such an index-driven strategy may not be the best investment strategy ever devised, the number of investment strategies that are worse is infinite.” (p. 259)

You must invest early.

• “We know that we must start to invest at the earliest possible moment, and continue to put money away regularly from then on. We know that investing entails risk. But we also know that not investing dooms us to financial failure.” (p. 260)

What’s the first investment decision I should make?

• “Benjamin Graham believed that your first investment decision should be how to allocate your investment assets: How much should you hold in stocks? How much in bonds? Graham believed that this strategic decision may well be the most important of your investment lifetime.” (p. 225)
  
  
• “First, and most important, you must make a strategic choice in allocating your assets between stocks and bonds. Differently situated investors with unique needs and circumstances will obviously make different decisions.” (p . 230)
  
  
• “A landmark 1986 academic study confirmed his view. The study found that asset allocation accounted for an astonishing 94 percent of the differences in total returns achieved by institutionally managed pension funds. That 94 percent figure suggests that long-term fund investors might profit by concentrating more on the allocation of their investments between stock funds and bond funds, and less on the question of which particular funds to hold.” (p. 225)

How do I figure out my asset allocation?

• “There are two fundamental factors that determine how you should allocate your portfolio between stocks and bonds: (1) your ability to take risk and (2) your willingness to take risk.” (p. 228)
  
  
• “Your ability to take risk depends on a combination of factors, including your financial position; your future liabilities (for example, retirement income, college tuition for your children and/or grandchildren, a down payment on a home); and how many years you have available to fund those liabilities. In general, you are able to accept more risk if these liabilities are relatively far in the future. Similarly, as you accumulate more assets relative to your liabilities, your ability to take risk increases.
  
  Your willingness to take risk, on the other hand, is purely a matter of preference. Some investors can handle the ups and downs of the market without worry. But if you can’t sleep at night because you’re frightened about the volatility of your portfolio, you’re probably taking more risk than you can handle. Taken together, your ability to accept risk and your willingness to accept risk constitute your risk tolerance.” (p. 228)
  

• “1.) Investors seeking to accumulate assets by investing regularly can afford to take somewhat more risk—that is, to be more aggressive—than investors who have a relatively fixed pool of capital and are dependent on income and even distributions from their capital to meet their day-to-day living expenses. 2.) Younger investors, with more time to let the magic of compounding work for them, can also afford to be more aggressive, while older investors will likely want to steer a more conservative course.” (p. 229)

What asset allocation does Bogle suggest?

• “When I discussed Graham’s philosophy in my 1993 book Bogle on Mutual Funds: New Perspectives for the Intelligent Investor, the use of just two asset classes was my starting point. My recommendations for investors in the accumulation phase of their lives, working to build their wealth, focused on a stock/bond mix of 80/20 for younger investors and 70/30 for older investors. For investors starting the postretirement distribution phase, 60/40 for younger investors, 50/50 for older investors.” (p. 227)
  
  
• “Let’s begin with a basic allocation model for the accumulation of assets for the wealth-building investor. The main points to consider are merely common sense. (1) Investors seeking to accumulate assets by investing regularly can afford to take somewhat more risk—that is, to be more aggressive—than investors who have a relatively fixed pool of capital and are dependent on income and even distributions from their capital to meet their day-to-day living expenses. (2) Younger investors, with more time to let the magic of compounding work for them, can also afford to be more aggressive, while older investors will likely want to steer a more conservative course.
  
  Graham’s allocation guidelines are reasonable; mine are similar but more flexible. Your common stock position should be as large as your tolerance to take risk permits. For example, my highest recommended general target allocation for stocks would be 80 percent for younger investors accumulating assets over a long time frame.
  
  My lowest target stock allocation, 25 percent, would apply to older investors late in their retirement years. These investors must give greater weight to the short-run consequences of their actions than to the probabilities of future returns. They must recognize that volatility of returns is an imperfect measure of risk. Far more meaningful is the risk that they will unexpectedly have to liquidate assets when cash is needed to meet living expenses—often in depressed markets—and perhaps receive less in proceeds than the original cost of the assets. In investing, there are no guarantees.” (p. 229)
  
  
• “I’ve often been cited as an advocate for a similar simple and seemingly rigid asset allocation: your bond position should equal your age, with the remainder in stocks. That asset allocation strategy can serve the needs of many—if not most—investors quite well, but it was never intended to be more than a rule of thumb, a place to begin your thought process. It is (or was!) based on the idea that when we are younger, have limited assets to invest, don’t need investment income, have a higher tolerance for risk, and believe that equities will provide higher returns than bonds over the long term, we should own more stocks than bonds.”
  
  
• “I hardly intended such an age-based rule of thumb to be rigidly applied. For example, surely many young investors beginning their first full-time jobs might as well regularly invest not 75 percent, but 100 percent of their savings in equities during those early years of investing.” (p. 241)

There are 4 decisions you need to make about your asset allocation.

• As an intelligent investor, you must make four decisions about your asset allocation program: First, and most important, you must make a strategic choice in allocating your assets between stocks and bonds. Differently situated investors with unique needs and circumstances will obviously make different decisions.
  
  
• Second, the decision to maintain either a fixed ratio or a ratio that varies with market returns cannot be sidestepped. The fixed ratio (periodically rebalancing to the original asset allocation) is a prudent choice that limits risk and may well be the better choice for most investors. The portfolio that is never rebalanced, however, is likely to provide higher long-term returns.
  
  
• Third is the decision as to whether to introduce an element of tactical allocation, varying the stock/bond ratio as market conditions change. Tactical allocation carries its own risks. Changes in the stock/bond ratio may add value, but (more likely, I think) they may not. In our uncertain world, tactical changes should be made sparingly, for they imply a certain prescience that few, if any, of us possess. In general, investors should not engage in tactical allocation.
  
  
• Fourth, and perhaps most important, is the decision as to whether to focus on actively managed mutual funds or traditional index funds. Clear and convincing evidence points to the index fund strategy. All four of these decisions require tough, demanding choices by the intelligent investor. With thoughtfulness, care, and prudence, you can make these choices sensibly.” (p. 230)

Here is some advice Bogle gave to a worried investor.

• “There is little science to establishing a precise asset allocation strategy. But we could do worse than beginning with Ben Graham’s central target of a 50/50 stock/bond balance, with a range limited to 75/25 and 25/75, divided between plain-vanilla stock and bond index funds. But allocations need not be precise.
  
  They are also about judgment, hope, fear, and risk tolerance. No bulletproof strategy is available to investors. Even I worry about the allocation of my own portfolio.
  
  In the letter that follows, I explain my concerns to a young investor worried about possible future catastrophes in our fragile world and in our changing society, as he tries to determine a sensible asset allocation for his own portfolio.
  
  “I believe that the U.S. economy will continue to grow over the long term, and that the intrinsic value of the stock market will reflect that growth. Why? Because that intrinsic value is created by dividend yields and earnings growth, which historically have had a correlation of about 0.96 with our nation’s economic growth as measured by GDP. (Close to 1.00, a perfect correlation.) Of course there will be times when stock market prices rise above (or fall below) that intrinsic value. This may well be a time when some overvaluation exists. (Or not. We can never be sure.) But in the long run, market prices have always, finally, converged on intrinsic value. I believe (with Warren Buffett) that’s just the way things are, totally rational.
  
  Substantial risks—some known, some unknown—of course exist. You and I know as much—or as little—about their happening as anyone else. We’re on our own in assessing the probabilities as well as the consequences. But if we don’t invest, we end up with nothing.
  
  My own total portfolio holds about 50/50 indexed stocks and bonds, largely indexed short- and intermediate-term. At my age of 88, I’m comfortable with that allocation. But I confess that half of the time I worry that I have too much in equities, and the other half of the time that I don’t have enough in equities.
  
  Finally, we’re all just human beings, operating in a fog of ignorance and relying on our circumstances and our common sense to establish an appropriate asset allocation.
  
  Paraphrasing Churchill on democracy, “my investment strategy is the worst strategy ever devised . . . except for every other strategy that has been tried.” I hope these comments help. Good luck.” (p. 234)
  
  And good luck to the readers of this chapter. Do your best, for there are no easy answers to the challenge of asset allocation.” (p. 234)

What asset allocation should I have during retirement?

• “In my 1993 Book Bogle on Mutual Funds, after discussing the large number of asset allocation strategies available to investors, I raised the possibility that “less is more”—that a simple mainstream (i.e., index) balanced fund, 60 percent in U.S. stocks, 40 percent in U.S. bonds, one that provides extraordinary diversification and operates at rock-bottom cost, would offer the functional equivalent of having your entire portfolio overseen by an investment advisory firm.
  
  It was in 1992 that I decided to form just such a 60/40 stock/bond balanced index fund at Vanguard. Viewed through the lens of the quarter-century that followed, the fund has been an extraordinary success” (p. 237)
  
  
• “Let’s look at the remarkable record of that balanced index fund. During its 25-year lifetime, the fund has earned an annual return of 8.0 percent, as compared to 6.3 percent for its peers, an advantage of 1.7 percentage points per year. That margin resulted in a compound advantage in cumulative return of 202 percentage points.
  
  The balanced index fund’s advantage has largely been the result of its low costs—an expense ratio of 0.14 percent versus 1.34 percent for its balanced mutual fund peer group. That expense ratio advantage and the remarkable 0.98 correlation of its annual returns with those of its peers (1.00 is perfect correlation) give us every reason to expect the balanced index fund to outperform its peers in the years ahead.
  
  Yes, an investor would have been better off by holding a low-cost S&P 500 Index fund, with an annual return of 9.3 percent during this period versus the balanced index fund’s return of 8.1 percent. With its lower volatility (balanced index 8.9 percent, 500 index 14.3 percent), its advantage in risk-adjusted return would be even higher. But when there was trouble, the balanced index fund offered exceptional protection. During 2000–2002, when the S&P 500 declined by 38 percent, the balanced index fund fell just 14 percent. In 2008, with the S&P 500 off 37 percent, the fund was off just 22 percent.
  
  For investors who have a very long time horizon, and considerable grit and guts—investors who have the courage to be unintimidated by periodic market crashes—clearly an allocation of 100 percent to the S&P 500 Index fund would nearly always be the better choice. (Its margin was unusually close over the past 25 years; I expect the spread to be wider going forward.)
  
  But what if you have a limited time horizon, or are cowed by stock market volatility and tempted to liquidate your stock portion when the seas are rough? Then the hands-off, set-the-allocation-and-stay-the-course strategy of the fixed 60/40 stock/bond asset allocation of the balanced index fund represents an option worthy of your serious consideration.” (p. 238)
  
  
• “The Wisdom of Benjamin Graham again”- “I see no reason for the retired investor to depart far from the advice that Benjamin Graham offered to all investors those many years ago, as reported in the previous chapter—a basic allocation of 50 percent stocks and 50 percent bonds, with a range of between 75/25 and 25/75. The higher equity portion for more risk-tolerant investors, perhaps seeking greater wealth for themselves and their heirs; the lower ratio for risk-averse investors, willing to sacrifice the potential for greater returns for some extra peace of mind.” (p. 240)
  
  
• “I’ve often been cited as an advocate for a similar simple and seemingly rigid asset allocation: your bond position should equal your age, with the remainder in stocks. That asset allocation strategy can serve the needs of many—if not most—investors quite well, but it was never intended to be more than a rule of thumb, a place to begin your thought process. It is (or was!) based on the idea that when we are younger, have limited assets to invest, don’t need investment income, have a higher tolerance for risk, and believe that equities will provide higher returns than bonds over the long term, we should own more stocks than bonds.
  
  But when we grow older and ultimately retire, most of us will have accumulated a significant investment portfolio. Then, we are apt to be more risk averse, more willing to sacrifice maximum capital appreciation and to rely more heavily on the higher income yields that bonds have provided over the past 60 years. Under these circumstances, we should own more bonds than stocks.” (p. 240)

The need to be flexible.

• I hardly intended such an age-based rule of thumb to be rigidly applied. For example, surely many young investors beginning their first full-time jobs might as well regularly invest not 75 percent, but 100 percent of their savings in equities during those early years of investing.
  
  And zero percent in equities is likely a dubious goal for a new centenarian. (We will have lots more centenarians as time goes on.) Continually selling equities by such an investor to reduce the stock allocation might not make much sense, especially if you consider the potential for large taxes on capital gains that are realized when stocks with substantial appreciation are sold.
  
  A flexible age-based plan comports with our common sense. But the many studies that have been done to validate the wide variety of similar (but more precise and more complex) allocation strategies have a common flaw: they are based on past returns on bonds and on stocks, neither of which seem likely to be repeated in the coming decade. (See Chapter 9.)” (p. 241)
  
  
• “Which brings me to an even more important point. As we age, we begin to rely less on the human capital that has largely got us to where we are today, and more on our investment capital. Finally, what’s most important when we retire is the stream of income we need to support our needs—the dividend checks we receive from our mutual fund investments and the monthly checks we receive from our Social Security payments.
  
  Yes, the market value of our capital is important. But frequent peeking at the value of our investments is not only unproductive, but counterproductive. What we really seek is retirement income that is steady and, if possible, grows with inflation.” (p. 242)

How much should I withdraw in Retirement?

• “Which brings me to an even more important point. As we age, we begin to rely less on the human capital that has largely got us to where we are today, and more on our investment capital. Finally, what’s most important when we retire is the stream of income we need to support our needs—the dividend checks we receive from our mutual fund investments and the monthly checks we receive from our Social Security payments.
  
  Yes, the market value of our capital is important. But frequent peeking at the value of our investments is not only unproductive, but counterproductive.
  
  What we really seek is retirement income that is steady and, if possible, grows with inflation. Social Security fits those criteria perfectly. And, with moderate risk, a balanced mutual fund portfolio can effectively supplement (or be supplemented by) Social Security payments. About half of the balanced portfolio’s income comes from interest on bonds, and the other half from dividends, mostly from large-cap stocks. With only three significant exceptions, the dividends on the S&P 500 Index have increased every year since the Index began 90 years ago, in 1926.” (p. 242)
  
  
• “A combination of Social Security payments and dividends from index funds (supplemented as necessary with withdrawals of capital) are likely to be an effective means of enjoying regular monthly income from your retirement assets. (Although few equity mutual funds pay dividends monthly, most have programs for providing regularly scheduled monthly payments.)
  
  The income yields on stocks and bonds are near historical lows (stocks 2 percent, bonds 3 percent), and because of the pernicious impact of mutual fund expenses, the yields on actively managed mutual funds are much lower, as we saw in Chapter 6. Such low yields are unlikely to adequately satisfy the retirement income needs of many investors. So investors will be better served to consider generating retirement income through a total return approach—using a combination of fund dividends and regular withdrawals from accumulated capital to generate a steady stream of monthly checks during retirement.” (p. 243)
  
  
• With the current interest rate on bonds at roughly 3 percent and the dividend yield on stocks at 2 percent (in both cases, before the high costs of actively managed funds), the income produced by your retirement portfolio is apt to fall well short of your retirement spending needs. A rule of thumb suggests that an annual withdrawal rate of 4 percent (including income and capital) of the year-end value of your initial retirement capital, adjusted annually for inflation, is likely—but by no means guaranteed—to be sustainable throughout your retirement years.
  
  Do not adhere rigorously to spending rules such as 4 percent annually. Maintain a level of flexibility in your retirement spending plan. If the markets are particularly bad and your spending rule would take too large a bite out of your portfolio, tighten your belt and draw down a little less. If the markets are good and your spending rate provides larger payments than you need, reinvest the unexpected windfall for the ever-uncertain future. By so doing, you’ll reduce spending from the portfolio when the markets are depressed and have the opportunity to recoup your capital when the markets recover. (p. 254)
  
  
• “Let me reiterate: Any asset allocation strategy is subject to numerous risks—stock market risk, payout risk, macroeconomic risk, and other risks in the fragile world in which we exist. All we can do is make informed judgments, and then be flexible in our allocation and payouts as conditions change.” (p. 255)

What about 100% stock allocation?

• “For investors who have a very long time horizon, and considerable grit and guts—investors who have the courage to be unintimidated by periodic market crashes—clearly an allocation of 100 percent to the S&P 500 Index fund would nearly always be the better choice. (Its margin was unusually close over the past 25 years; I expect the spread to be wider going forward.)” (p. 239)
  
  
• “I hardly intended such an age-based rule of thumb to be rigidly applied. For example, surely many young investors beginning their first full-time jobs might as well regularly invest not 75 percent, but 100 percent of their savings in equities during those early years of investing.” (p. 241)
  
  
• “But what if you have a limited time horizon, or are cowed by stock market volatility and tempted to liquidate your stock portion when the seas are rough? Then the hands-off, set-the-allocation-and-stay-the-course strategy of the fixed 60/40 stock/bond asset allocation of the balanced index fund represents an option worthy of your serious consideration.” (p.239)

Which stocks should I buy?

• “Simple arithmetic suggests, and history confirms, that the winning strategy for investing in stocks is to own all of the nation’s publicly held businesses at very low cost. By doing so you are guaranteed to capture almost the entire return that these businesses generate in the form of dividends and earnings growth. The best way to implement this strategy is indeed simple: Buy a fund that holds this all-market portfolio, and ​hold it forever. Such a fund is called an index fund.” (p. XV)
  
  
• “Simply buy a Standard & Poor’s 500 Index fund or a total stock market index fund. Then, once you have bought your stocks, get out of the casino—and stay out. Just hold the market portfolio forever. And that’s what the traditional index fund does.” (p. XXIII)
  
  
• “Mr. Buffett spoke these words directly to me at a dinner in Omaha in 2006: “A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.” (p.221)

Why would an intelligent investor hold bonds?

• “Why would an intelligent investor hold bonds? Over the long term, history tells us that stocks have generally provided higher returns than bonds. That relationship is expected to continue during the coming decade, although rational expectations suggest that future returns both on stocks and on bonds are almost certain to fall well short of historical norms. As noted in Chapter 9, I estimate that annual returns on bonds over the coming decade will average 3.1 percent. To summarize, since 1900, annual returns on bonds have averaged 5.3 percent; since 1974, 8.0 percent; in the coming decade, likely 3.1 percent, plus or minus.”
  
  
• “So today, why would an intelligent investor hold any bonds at all? First, because the long run is a series of short runs, and during many short periods, bonds have provided higher returns than stocks. In the 117 years since 1900, bonds have outpaced stocks in 42 years; in the 112 five-year ​periods, bonds have outpaced stocks 29 times; and even in the 103 fifteen-year periods, bonds have outpaced stocks 13 times. “
  
  
• “Second, and perhaps more important, reducing the volatility of your portfolio can give you downside protection during large market declines, an anchor to windward, so to speak. The conservative nature of a balanced stock/bond portfolio can reduce the possibility of counterproductive investor behavior (i.e., getting frightened when the stock market plunges and liquidating your stock position).”
  
  
• Third, while bond yields are near their lowest levels since the early 1960s, the current yield on bonds (3.1 percent) still exceeds the dividend yield on stocks (2 percent).” (p. 169)

Which bonds should I buy?

• Buy a Total Bond Market Index Fund.
  
  “The reality is that the value of bond index funds is derived from the same forces that create value in stock index funds: broad diversification, rock-bottom costs, disciplined portfolio activity, tax efficiency, and focus on shareholders who place their trust in long-term strategies. ​It is these commonsense characteristics that enable index funds to guarantee that you will earn your fair share of the returns in the stock and bond markets, even as they do in all financial markets.” (p. 175)

What about adding corporate bonds to a total market index fund?

• “The first total bond market index fund—formed in 1986, and still the largest—tracks the Bloomberg Barclays U.S. Aggregate Bond Index. Nearly all of the major all-bond-market index funds have followed the leader. These index funds are extremely high in quality (63 percent U.S. government-backed bonds, another 5 percent in AAA-rated corporates, 32 percent rated AA through BAA, and no bonds rated below investment grade). During the past 10 years, that total bond market index fund earned an annual return of 4.41 percent, just 0.05 percentage points behind the 4.46 percent annual return of its target index, a remarkable parallel.”
  
  
• “Since high-quality portfolios almost always produce lower yields than lower-quality portfolios, the total bond market index fund’s yield in mid-2017 is a relatively low 2.5 percent when compared to the 3.1 percent yield of the bond market proxy that we used earlier in this chapter. The difference: the bond portfolio that we constructed for this analysis underweights U.S. government issues (50 percent) and overweights investment-grade corporate bonds (50 percent) relative to the index, thus producing its higher yield.
  
  In order to achieve such a 50/50 government/corporate bond portfolio, investors who require a higher yield than the total bond market index fund (yet still seek a high-quality portfolio) might consider a portfolio consisting of 75 percent in the total bond market index fund and 25 percent in an investment-grade corporate bond index fund.” (p. 174)

Why do managers pick different kinds of bonds?

• “Managers also may be tempted to increase returns by reducing the investment quality of the portfolio, holding less in U.S. Treasury bonds (rated AA+) or in investment-grade corporate bonds (rated BBB or better), and holding more in below-investment-grade bonds (BB or lower), or even some so-called junk bonds, rated below CC or even unrated. Heavy reliance on junk bonds to increase the income generated by your portfolio subjects your bond investment to high risks. (Of course!) Investors who seek to increase the yield on their bond portfolios by investing in junk bond funds should limit themselves to small allocations. Caution is advised!” (p. 171)
  
  
• “While these costs make the task of improving returns far more difficult, overly confident bond fund managers may be tempted to take just a little extra risk by extending maturities of the bonds in the portfolio. (Long-dated bonds—with, say, 30-year maturities—are much more volatile than short-term bonds—say, two years—but usually provide higher yields.)” (p. 170)

There are three type of bond funds.

• “One beneficial feature of bond mutual funds is that they often offer investors three (or more) options that deal with the trade-off between return and risk. Short-term portfolios are designed for investors who are willing to sacrifice yield to reduce volatility risk. Long-term portfolios serve investors who want to maximize yield and are prepared to deal with higher volatility. And intermediate-term portfolios seek a balance between income opportunity and market volatility. These options help make bond funds attractive to investors with a variety of strategies.” (p 171)

Should I rebalance my stocks and bonds?

• “The fixed ratio (periodically rebalancing to the original asset allocation) is a prudent ​choice that limits risk and may well be the better choice for most investors. The portfolio that is never rebalanced, however, is likely to provide higher long-term returns.” (p. 230)

Should you vary stock/bond ratio as markets change?

• Third is the decision as to whether to introduce an element of tactical allocation, varying the stock/bond ratio as market conditions change. Tactical allocation carries its own risks. Changes in the stock/bond ratio may add value, but (more likely, I think) they may not. In our uncertain world, tactical changes should be made sparingly, for they imply a certain prescience that few, if any, of us possess. In general, investors should not engage in tactical allocation.” (p. 231)

Does Bogle recommend international stocks?

• “I advised investors that they did not need to hold non-U.S. stocks in their portfolios, and in any event should not allocate more than 20 percent of their stock portion to non-U.S. stocks. ​My view that a U.S.-only equity portfolio will serve the needs of most investors was (and still is) challenged by, well, everyone. As the argument goes, “Isn’t omitting non-U.S. stocks from a diversified portfolio just as arbitrary as, say, omitting the technology sector from the S&P 500?” (p. 244)
  
  
• “I argued the contra side. We Americans earn our money in dollars, spend it in dollars, save it in dollars, and invest it in dollars, so why take currency risk? Haven’t U.S. institutions been generally stronger than those of other nations? Don’t half of the revenues and profits of U.S. corporations already come from outside the United States? Isn’t U.S. gross domestic product (GDP) likely to grow at least as fast as the GDP of the rest of the developed world, perhaps at an even higher rate?
  
  The advice in my 1993 book has worked out well. For whatever reason, my advice has worked out well. Since 1993, the U.S. S&P 500 Index has earned an average annual return of 9.4 percent (cumulative +707 percent). The non-U.S. portfolio—I refer here to the MSCI Europe, Australasia, and Far East Index (EAFE)—has had an annual return of 5.1 percent (+216 percent). ​That said, perhaps the relative advantage achieved in the U.S. stock market over the past quarter-century has now been arbitraged away, and that long period of relative underperformance by non-U.S. stocks has led to more attractive valuations abroad. Who really knows? So you will have to consider the probabilities and make your own judgment.” (p. 245)

What is John Bogle’s own asset allocation?

• “My own total portfolio holds about 50/50 indexed stocks and bonds, largely indexed short- and intermediate-term. At my age of 88, I’m comfortable with that allocation. But I confess that half of the time I worry that I have too much in equities, and the other half of the time that I don’t have enough in equities. Finally, we’re all just human beings, operating in a fog of ignorance and relying on our circumstances and our common sense to establish an appropriate asset allocation.” (p. 235)

Here is the advice Bogle gave to a worried investor.

• “A human perspective: advice to a worried investor. There is little science to establishing a precise asset allocation strategy. But we could do worse than beginning with Ben Graham’s central target of a 50/50 stock/bond balance, with a range limited to 75/25 and 25/75, divided between plain-vanilla stock and bond index funds. But allocations need not be precise. They are also about judgment, hope, fear, and risk tolerance. No bulletproof strategy is available to investors. Even I worry about the allocation of my own portfolio. In the letter that follows, I explain my concerns to a young investor worried about possible future catastrophes in our fragile world and in our changing society, as he tries to determine a sensible asset allocation for his own portfolio.
  
  I believe that the U.S. economy will continue to grow over the long term, and that the intrinsic value of the stock market will reflect that growth. Why? Because that intrinsic value is created by dividend yields and earnings growth, which historically have had a correlation of about 0.96 with our nation’s economic growth as measured by GDP. (Close to 1.00, a perfect correlation.) Of course there will be times when stock market prices rise above (or fall below) that intrinsic value. This may well be a time when some overvaluation exists. (Or not. We can never be sure.) But in the long run, market prices have always, finally, converged on intrinsic value. I believe (with Warren Buffett) that’s just the way things are, totally rational.
  
  Substantial risks—some known, some unknown—of course exist. You and I know as much—or as little—about their happening as anyone else. We’re on our own in assessing the probabilities as well as the consequences. But if we don’t invest, we end up with nothing.
  
  My own total portfolio holds about 50/50 indexed stocks and bonds, largely indexed short- and intermediate-term. At my age of 88, I’m comfortable with that allocation. But I confess that half of the time I worry that I have too much in equities, and the other half of the time that I don’t have enough in equities. Finally, we’re all just human beings, operating in a fog of ignorance and relying on our circumstances and our common sense to establish an appropriate asset allocation. Paraphrasing Churchill on democracy, “my investment strategy is the worst strategy ever devised . . . except for every other strategy that has been tried.” I hope these comments help. Good luck.” (p. 234

What does bogle predict for future returns?

• “In the long run it is the reality of business—the dividend yields and earnings growth of corporations—that drives the returns generated by the stock market. Paradoxically, however, if we simply consider only the 43 years since I founded Vanguard on September 24, 1974, the returns provided by the stock market exceeded the returns earned by businesses by among the highest margins in any period of such length in the entire history of the U.S. market.
  
  Specifically, the dividend yields and earnings growth of the public corporations that compose the Standard & Poor’s 500 Index created an investment return of but 8.8 percent during that period (dividend yield 3.3 percent, earnings growth 5.5 percent), yet the total annual return was 11.7 percent. (See Exhibit 9.1.)
  
  Fully 2.9 percentage points of the market’s return—fully 25 percent of the total—were accounted for by speculative return. That return reflected an upward revaluation of stocks by investors, as the price/earnings multiple more than tripled, from 7.5 times earnings to 23.7 times. (The average decade-long contribution of speculative return to the market’s total annual return since 1900 has been but 0.5 percentage points, only about one-fifth of the bounty that we investors have enjoyed since 1974.)” (p. 93)
  
  
• “On balance over more than four decades, equity investors have enjoyed extraordinary returns. But since speculative return was responsible for fully 25 percent of the market’s annual return during this period, it is unrealistic to expect P/E multiple expansion to repeat that performance, nor to give much, if any, momentum to the investment returns earned by stocks in the decade ahead. Common sense tells us that compared to the long-term annual nominal return of 9.5 percent since 1900, we’re again facing an era of subdued returns in the stock market (Exhibit 9.2). (p. 96)
  
  
• “Let’s consider the sources of return as they appear today. First, today’s dividend yield on stocks is not 4.4 percent (the historical rate), but 2 percent. Thus we can expect a deadweight loss of 2.4 percentage points per year in the contribution of dividend income to investment return.
  
  As for corporate earnings, let’s assume that they will continue to grow (as, over time, they usually have) at about the pace of our economy’s expected nominal growth rate of 4 percent to 5 percent per year in gross domestic product (GDP) over the coming decade, below our nation’s long-term nominal growth rate of 6 percent plus.
  
  If that expectation proves to be reasonably accurate, then the most likely expectation for the investment return on stocks would be in the range of 6 percent to 7 percent. I’ll be cautious and project an annual investment return averaging 6 percent.
  
  Future annual speculative return—minus 2 percent?
  
  Now consider speculative return. As 2017 began, the price/earnings multiple on stocks was 23.7 times. That figure is based on the past year’s reported earnings of the S&P 500. If the P/E ratio remains at that level a decade hence, speculative return would neither add to nor subtract from that possible 6 percent investment return. Wall Street strategists generally prefer to calculate the P/E using projected operating earnings for the coming year, rather than past reported earnings. Such operating earnings exclude write-offs for discontinued business activities and other bad stuff, and projections of future earnings that may or may not be realized. Using projected operating earnings, Wall Street’s P/E ratio is only 17 times. I would disregard that projection.
  
  My guess—an informed guess, but still a guess—is that, by decade’s end, the P/E ratio might ease down to, say, 20 times or even less. Such a revaluation would reduce the market’s return by about 2 percentage points per year, resulting in an annual rate of return of 4 percent for the U.S. stock market.” (p. 98)
  
  
• “So I’ll develop my expectation for future returns on bonds based on a portfolio consisting of 50 percent U.S. Treasury notes now yielding 2.2 percent and 50 percent long-term investment-grade corporate bonds now yielding 3.9 percent. This combination produces a 3.1 percent yield on a broadly diversified bond portfolio. So, reasonable expectations suggest an annual return of 3.1 percent on bonds over the next decade.
  
  During the coming decade, the returns on bonds, like the returns on stocks, are likely to fall well short of historical norms (Exhibit 9.4). Over the long sweep of history since 1900, the annual return on bonds has averaged 5.3 percent. During the modern era since 1974, the return on bonds has been far higher, averaging 8.0 percent annually. That return has been driven largely by the long, steady bull market that began in 1982 as interest rates tumbled and prices rose.” (p. 103)
  
  
• “Finally, we know what we don’t know. We can never be certain how our world will look tomorrow, and we know far less about how it will look a decade hence. But with intelligent asset allocation and sensible investment choices, we can be prepared for the inevitable bumps along the road, and should glide right through them.” (p. 261)

Other Good Quotes:

“Don’t think that you know more than the market; no one does. And don’t act on insights that you think are your own but are usually shared by millions of others.” (p. 264)

“Even after more than 66 years in this business, I have almost no idea how to forecast these short-term swings in investor emotions.” (p. 20)

“You should know that, in establishing a trust for his wife’s estate, Warren Buffett directed that 90 percent of its assets be invested in a low-cost S&P 500 Index fund.” (p. 37)

“Focusing on the long term, doing one’s best to ignore the short-term noise of the stock market, and eschewing the hot funds of the day, the index fund can be held through thick and thin for an investment lifetime. Emotions need never enter the equation. The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing. Just stay the course.” (p. 82)

“While the interests of Wall Street’s businesses are well served by the aphorism “Don’t just stand there—do something!,” the interests of Main Street’s investors are well served by an approach that is its diametrical opposite: “Don’t do something—just stand there!” (p. 266)

“In previous chapters, we’ve demonstrated—pretty much unequivocally—the success of index funds in providing long-term returns to investors that have vastly surpassed the returns achieved by investors in actively managed mutual funds.” (p. 195)

“Traditional market-cap-weighted index funds (such as the Standard & Poor’s 500) guarantee that you will receive your fair share of stock market returns, and virtually assure that you will outperform, over the long term, at least 90 percent of the other investors in the marketplace.”(p. 205)

Benjamin Graham said, “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, but the situation has changed a great deal since then. In the old days, any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies. But in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.” (p. 218)

“Mr. Buffett spoke these words directly to me at a dinner in Omaha in 2006: “A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.” (p.221)

Hear Warren Buffett: “Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.” (p. 260)