Three weeks ago, financial services pioneer John Bogle passed away at the age of 89. While not the originator of the concept, Jack, as he was known by most, was the first person to create an index fund. This first fund would invest in the stock of 500 large U.S. companies, tracking an index developed by Standard & Poor’s commonly known as the S&P 500. Given TAAG’s investment philosophy and how we view markets, were we to commission a Mt. Rushmore of investing, Jack would make the list.
His initial reward for this effort? The market performed poorly right out of the gate and the idea struggled to gain traction. It didn’t help that the entire industry attacked his idea as “un-American,” distributing posters with slogans like “Stamp Out Index Funds!” to warn investors about this dangerous investment tool. Some referred to the whole idea as nothing more than the pursuit of mediocrity.
That pursuit ultimately led Bogle to found Vanguard* which today manages more than $5 trillion, employs nearly 17,000 people and is considered one of the most respected, low-cost retail mutual fund companies on Earth. Bogle kept one of the “Stamp Out” posters hanging outside his office in Malvern, Pennsylvania throughout his life.
While the battle between whether index investing (also known as passive investing or evidence based investing) and active investing best suits investors remains a divisive topic in the financial world, the pendulum has certainly been moving swiftly in favor of indexing of the last several years.
A recent re-broadcast of NPR’s Planet Money podcast in Jack Bogle’s honor detailed a famous bet between Warren Buffet and a hedge fund manager. Buffet commented at the 2016 annual meeting of Berkshire Hathaway that hedge funds were not worth the cost of investing and he would bet anyone that he could beat them.
A hedge fund manager, Ted Seides, took the Oracle of Omaha up on his bet. After going back and forth on terms, they bet $1 million that Buffet’s investment selection would defeat a portfolio of hedge funds of Ted’s choosing.
Warren’s investment pick? The Vanguard S&P 500 Index fund. About as plain vanilla, boring a pick as you could possibly make.
The bet commenced January 1, 2007 and would conclude December 31, 2017.
Most of us remember what happened in 2008. Right from the start, Buffet faced long odds. The hedge funds only lost around 25% that year while the index fund was down closer to 40%. Ouch.
Then the market turned a corner the following March ending up quite a bit in 2009. It was up again in 2010 and 2011 and so on. By the end of 2015, the S&P 500, including the market crash of 2008-2009 was up 66%. Ted Seides’ basket of hedge funds? Just 22%.
Seides started doubting his ability to win.
By the end of 2017, with Warren’s fund having returned 7.1% per year for the entire decade and the hedge funds returning just 2.2% after expenses, Mr. Seides made a very generous donation of $1 million to Girls, Inc. of Omaha, a favorite charity of Mr. Buffet’s.
A Word on Diversification
Critics will argue that, despite the S&P 500 returning 10.2% per year on average going all the way back to 1926, there are still periods of time, even 10-year periods, where this bet would have been a different story.
We don’t have to leave this century to provide an example. From January 2000 through December 2009, the S&P 500 averaged a slightly negative return per year for the entire decade. It’s impossible to say what Seides would’ve been able to do during this same time, but it’s reasonable to believe he could have outperformed the index.
We would agree, in part, with those critics. Investing solely in large, U.S. companies is still too concentrated for our taste. Having a globally diversified portfolio, one that takes a similar approach as the S&P 500 fund with large U.S. companies, but includes companies large and small from all over the world provides an even greater chance at long term success. That is a different blog for a different day.
Regardless, while Mr. Buffet’s tale is one of victory, there are certainly times when accepting average market returns might mean not winning.
Never Losing Doesn’t Feel as Good as Winning
With an understanding that attempting to outguess markets is a fool’s errand and that investing in a globally diverse portfolio at a low cost is the best available way to achieve success over long periods of time, why doesn’t it feel like it?
Well, like Buffet, most humans are wired to want to win. Accepting the above means never being the top performer out of all the various asset classes that make up the global market. In fact, if you’re earning the average of a basket of investments or asset classes, you’re guaranteed to never being the top performer.
Of course, it also means that market losses will be muted in bad times. But not losing as much as you could have doesn’t feel particularly good either, right? Losing still feels like losing.
No big wins to talk about on the golf course or at the cocktail party and still much of the fear and uncertainty that comes with market risk on the downside. I’m supposed to get excited about this?
Looking at data from Standard & Poor’s SPIVA scorecard, a tracking of various investment indices, when looking at 15-year periods, less than 8% of actively managed funds outperform their respective benchmark. The data isn’t that much better for active managers in 5 & 10-year periods and worse when you look beyond 15 years.
That means that accepting “average” investment returns over 15-year or longer-term time horizons will find investors outperforming 92% of actively managed strategies. Most would agree this is anything but average.
The path to a successful investment strategy must include periods of loss as well as gain. There’s no free lunch out there. Challenging this would be asking for out sized returns for undersized risk, which intuitively we know to be impossible.
While we may need to find other pursuits to feed our need to win, it’s worth tipping our caps to people like Jack Bogle who spent a lifetime demonstrating that a disciplined, evidence-based path to success can be far more exciting than it may feel in the moment.
*While we don’t use Vanguard funds in our typical portfolios, we do occasionally recommend their funds to clients and others with whom we discuss investing.