There are countless books, articles, seminars and pundits explaining how to beat the market and strike it rich by choosing the hot stocks of the day or by following some magic formula.


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There are countless books, articles, seminars and pundits explaining how to beat the market and strike it rich by choosing the hot stocks of the day or by following some magic formula.

Investing pioneer John Bogle says this is a loser’s game. But he provides a smart alternative.

Investing pioneer John Bogle says this is a loser’s game. But he provides a smart alternative. 


Fortune magazine named Bogle “one of the four investment giants of the 20th Century” because he pioneered the index fund. He also wrote the bestselling The Little Book of Common Sense Investing.

Fortune magazine named Bogle “one of the four investment giants of the 20th Century” because he pioneered the index fund. He also wrote the bestselling The Little Book of Common Sense Investing.


The index fund is a very broadly diversified fund which tracks the performance of the stock market as a whole - for instance, the Standard &amp; Poor’s 500 Index - the ‘S&amp;P 500’.

The index fund is a very broadly diversified fund which tracks the performance of the stock market as a whole - for instance, the Standard & Poor’s 500 Index - the ‘S&P 500’. 


When you as an individual investor buy into such a fund, you’re buying a piece of the overall US economy. Whenever the economy grows (which it always does, in the long run), and you own a fund that tracks the market, you get your fair share of the bigger pie.

When you as an individual investor buy into such a fund, you’re buying a piece of the overall US economy. Whenever the economy grows (which it always does, in the long run), and you own a fund that tracks the market, you get your fair share of the bigger 

Bogle noted how too many people lose their money by betting on individual stocks which fail. They don’t diversify. They compound this mistake by pulling their money out when the economy is rough – they don’t take a long view.

Bogle noted how too many people lose their money by betting on individual stocks which fail. They don’t diversify. They compound this mistake by pulling their money out when the economy is rough – they don’t take a long view. 


The fact is, the US economy has always grown healthily in the long term, and index funds precisely follow this growth. If you want to get wealthy over time and sleep at night, they are easily the best thing for it.

The fact is, the US economy has always grown healthily in the long term, and index funds precisely follow this growth. If you want to get wealthy over time and sleep at night, they are easily the best thing for it.


From 1900 to 2016, the US stock market has had a 9.5 percent average annual total return.

From 1900 to 2016, the US stock market has had a 9.5 percent average annual total return. 


OK, but shouldn’t I time the market and find the hot stocks when they are cheap and sell them when they are expensive?

OK, but shouldn’t I time the market and find the hot stocks when they are cheap and sell them when they are expensive? 


In theory, yes, but the reality is that the average investor should forget about finding ‘hot’ stocks, Bogle says. The numbers show that you just cannot beat the market (indeed, not even many highly-paid professionals can).

In theory, yes, but the reality is that the average investor should forget about finding ‘hot’ stocks, Bogle says. The numbers show that you just cannot beat the market (indeed, not even many highly-paid professionals can).


Understanding the economy

You might ask: if the economy grows at less than 10 percent per year, how could you ever multiply your wealth and become rich? This is where the magic happens.

You might ask: if the economy grows at less than 10 percent per year, how could you ever multiply your wealth and become rich? This is where the magic happens.


Albert Einstein called compound interest “the most powerful force in the universe”. Take the growth of $1 over time at an annual return of 7%. After ten years, the dollar doubles in value.

Albert Einstein called compound interest “the most powerful force in the universe”. Take the growth of $1 over time at an annual return of 7%. After ten years, the dollar doubles in value. 


Ten years later, it grows to $4. Another ten years, and it’s become $7.50. A decade after that, $15. After 50 years, an investment of a single dollar grows to thirty dollars.

Ten years later, it grows to $4. Another ten years, and it’s become $7.50. A decade after that, $15. After 50 years, an investment of a single dollar grows to thirty dollars. 


Bogle provides an example of an investor in his own first index mutual fund, which opened in 1976. Having invested $15,000 in that year, by 2016 that person’s investment would have grown to a staggering $913,340. That’s the magic of compounding.

Bogle provides an example of an investor in his own first index mutual fund, which opened in 1976. Having invested $15,000 in that year, by 2016 that person’s investment would have grown to a staggering $913,340. That’s the magic of compounding.


Of course, because of inflation, $15,000 in 1976 was worth much more than it is worth now. However, even taking into account an average inflation rate of 3.4%, the annual return from index funds has been a very healthy 6.7%.

Of course, because of inflation, $15,000 in 1976 was worth much more than it is worth now. However, even taking into account an average inflation rate of 3.4%, the annual return from index funds has been a very healthy 6.7%.


So on average and in the long run, the whole market grows by 6.7% in real terms. But some companies grow much faster. Shouldn’t we be trying to identify those firms with great potential and thus beat the market average?

So on average and in the long run, the whole market grows by 6.7% in real terms. 
But some companies grow much faster. Shouldn’t we be trying to identify those firms with great potential and thus beat the market average?


The short answer is ‘no’. To beat the market - or as academic researchers call it, produce ‘positive alpha’ - means to make more money on the stock market than the benchmark, the S&amp;P 500 index.

The short answer is ‘no’. To beat the market - or as academic researchers call it, produce ‘positive alpha’ - means to make more money on the stock market than the benchmark, the S&P 500 index.


Some portfolio managers believe that they can do this. More importantly, they succeed in convincing others that they can do this. But it’s a delusion, Bogle says.

Some portfolio managers believe that they can do this. More importantly, they succeed in convincing others that they can do this. But it’s a delusion, Bogle says. 


Some investment managers perform better than the market average, but it may be pure chance. Some managers will show exceptionally good performance, but sooner or later the inescapable ‘regression to the mean’ kicks in.

Some investment managers perform better than the market average, but it may be pure chance. Some managers will show exceptionally good performance, but sooner or later the inescapable ‘regression to the mean’ kicks in.


In every mutual fund prospectus, Bogle notes, the following warning appears: ‘Past performance is no guarantee of future results.’ Believe it!

In every mutual fund prospectus, Bogle notes, the following warning appears: ‘Past performance is no guarantee of future results.’ Believe it!


The magic of compounding

A key reason that fund managers and investors generally fail to beat the market is that they don’t diversify. They may do well on one particular stock… or they could lose all their money on it.

A key reason that fund managers and investors generally fail to beat the market is that they don’t diversify. They may do well on one particular stock… or they could lose all their money on it. 


The best diversification strategy is not just to buy, say, a dozen companies, but to buy the whole market. “Don’t look for the needle,” Bogle says. “Buy the haystack.” The haystack is the index or tracker fund.

The best diversification strategy is not just to buy, say, a dozen companies, but to buy the whole market. “Don’t look for the needle,” Bogle says. “Buy the haystack.” The haystack is the index or tracker fund.


Bogle looked into the performance of 355 actively managed funds (i.e. handpicked stock) which existed in 1970. By 2016, 80% of the funds did not exist. Underperforming funds were taken off the market, or merged with other funds, to avoid the owners’ getting a bad reputation and losing clients.

Bogle looked into the performance of 355 actively managed funds (i.e. handpicked stock) which existed in 1970. By 2016, 80% of the funds did not exist. Underperforming funds were taken off the market, or merged with other funds, to avoid the owners’ getti

From 1970 to 2016, only 10 out of 355 funds performed better than the S&amp;P 500 by more than 1 percentage point per year. There were only two funds which outperformed the S&amp;P 500 by more than 2 percentage points: Fidelity Magellan and Fidelity Contrafund.

From 1970 to 2016, only 10 out of 355 funds performed better than the S&P 500 by more than 1 percentage point per year. There were only two funds which outperformed the S&P 500 by more than 2 percentage points: Fidelity Magellan and Fidelity Contrafund. 


Peter Lynch became an investing legend for managing Fidelity from 1977 to 1990 and making it arguably the greatest success story in the history of mutual funds.

Peter Lynch became an investing legend for managing Fidelity from 1977 to 1990 and making it arguably the greatest success story in the history of mutual funds. 


But there is more to the story than meets the eye, Bogle says. Fidelity’s performance was best in the early years, when it outpaced the S&amp;P 500 by an average of 10 percentage points per year. After 1994, its performance was already worse than the S&amp;P.

But there is more to the story than meets the eye, Bogle says. Fidelity’s performance was best in the early years, when it outpaced the S&P 500 by an average of 10 percentage points per year. After 1994, its performance was already worse than the S&P. 


If only two funds out of 355 outperformed the S&amp;P 500 by more than 2% for any length of time, it means you would have had less than 0.6% chance of significantly beating the market in the long-term by investing in an actively managed mutual fund like Magellan.

If only two funds out of 355 outperformed the S&P 500 by more than 2% for any length of time, it means you would have had less than 0.6% chance of significantly beating the market in the long-term by investing in an actively managed mutual fund like Magel

To put it another way, you would face a 99.4% probability of not beating it. This is a “loser’s game”, Bogle says. Don’t play it.

To put it another way, you would face a 99.4% probability of not beating it. This is a “loser’s game”, Bogle says. Don’t play it.


OK, but what happens when economic crises strike, and the entire market goes down? The best protection is having part of your portfolio invested in bonds. Here, too, the best idea is to invest in low-cost, low-risk, highly-diversified bond market index funds.

OK, but what happens when economic crises strike, and the entire market goes down? The best protection is having part of your portfolio invested in bonds. Here, too, the best idea is to invest in low-cost, low-risk, highly-diversified bond market index fu

The message is simple: never speculate on the random movements of the stock market. Instead, buy a balanced portfolio of stock and bond index funds, and keep them forever. Ignore this advice, and you won’t only fail to beat the market. You’ll pay for it dearly.

The message is simple: never speculate on the random movements of the stock market. Instead, buy a balanced portfolio of stock and bond index funds, and keep them forever. Ignore this advice, and you won’t only fail to beat the market. You’ll pay for it d

Diversify, diversify

If it’s impossible to beat the market over the long term, how can you get an edge? The answer is to keep your cost of investing extremely low. It’s the basic law of arithmetic: revenue minus costs equals profit.

If it’s impossible to beat the market over the long term, how can you get an edge? The answer is to keep your cost of investing extremely low. It’s the basic law of arithmetic: revenue minus costs equals profit.


Management fees, portfolio turnover fees, brokerage commissions - all these expenses add up to the total costs of investing. And as retail investors, we pay them whether or not our investing returns are positive or negative.

Management fees, portfolio turnover fees, brokerage commissions - all these expenses add up to the total costs of investing. And as retail investors, we pay them whether or not our investing returns are positive or negative. 


The ‘tyranny of compounding costs’ means that just as profits can accumulate over time, so can costs.

The ‘tyranny of compounding costs’ means that just as profits can accumulate over time, so can costs.


Say you invest $10,000 and assume an annual return of 7 percent. With the magic of compounding, after 50 years your investment will grow to $294,600.

Say you invest $10,000 and assume an annual return of 7 percent. With the magic of compounding, after 50 years your investment will grow to $294,600. 


But even if your investing costs are ‘just’ 2% annually, instead of almost $300,000 you will be left with only $114,700. How is this so? In the end, you only lose 2% of your investment, right?

But even if your investing costs are ‘just’ 2% annually, instead of almost $300,000 you will be left with only $114,700. How is this so? In the end, you only lose 2% of your investment, right?


Wrong. After a year, you indeed lose only 2%. Even after a decade, the 2% annual fees translate into ‘only’ a 17% loss. But over 50 years, a seemingly small annual fee of 2% consumes 61% of the potential accumulation that you could earn without fees.

Wrong. After a year, you indeed lose only 2%. Even after a decade, the 2% annual fees translate into ‘only’ a 17% loss. But over 50 years, a seemingly small annual fee of 2% consumes 61% of the potential accumulation that you could earn without fees.


Bogle puts it this way: “You put up 100% of the capital and you assume 100% of the risk. But you earn less than 40% of the potential return.”

Bogle puts it this way: “You put up 100% of the capital and you assume 100% of the risk. But you earn less than 40% of the potential return.”


One of Bogle’s favorite sayings was “don’t do anything, just stand there”. It sums up the distinction between passive and active investing - or indeed between investing and speculation.

One of Bogle’s favorite sayings was “don’t do anything, just stand there”. It sums up the distinction between passive and active investing - or indeed between investing and speculation. 


Warren Buffett put it similarly: “For investors as a whole, returns decrease as motion increases.” He meant that if you play the long game and take a stake in your nation’s growing prosperity, you’ll inevitably do well. But you must see yourself as an investor in companies, not a ‘trader’.

Warren Buffett put it similarly: “For investors as a whole, returns decrease as motion increases.” He meant that if you play the long game and take a stake in your nation’s growing prosperity, you’ll inevitably do well. But you must see yourself as an inv

If you invest in the stock market (and you need to, to keep returns above inflation),  putting your money into a fund that owns a bit of every company in the market is a simple strategy, but a smart one. Over time, it’s an almost worry-free way to accumulate wealth.

If you invest in the stock market (and you need to, to keep returns above inflation),  putting your money into a fund that owns a bit of every company in the market is a simple strategy, but a smart one. Over time, it’s an almost worry-free way to accumul

Costs and fees matter… a lot

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