Bogleheads Investment Philosophy

1 Develop a workable plan

2 Invest early and often

3 Never bear too much or too little risk

4 Diversify

5 Never try to time the market

6 Use index funds when possible

7 Keep Costs Low

8 Minimize taxes

9 Invest with simplicity

10 Stay the course

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1. Develop a workable plan

• Live below your means. Perhaps the most important idea underlying the Bogleheads’ approach to investing is to save a significant portion of income every month in order to secure a comfortable retirement.

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• Develop a sensible household budget - one that provides for needed expenditures, discretionary pleasures, savings for big-ticket items, and savings for long-term retirement planning.

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• Avoid excess debt, such as credit cards and home equity loans.

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• If you have such debt, pay off those balances first. Reduce expenses and unneeded debt so you can consistently set aside a portion of earnings for decades.

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2. Invest early and often

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Starting a regular savings plan early in life is important because compounding has a longer period to further increase investment returns. The table demonstrates the advantages of starting regular savings as early as possible. Leandra starts saving $2000 a year at age twenty five. Kevin waits until age forty to begin saving and investing. Kevin invests $ 5000 a year. Both Leandra's and Kevin's investments grow at an 8% compound rate of return.

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3. Never bear too much or too little risk

Asset Allocation strategies:

Risk Tolerance Assessment

90% equities 10% bonds - very aggressive

70% equities 30% bonds - aggressive

50% equities 50% bonds - moderate

30% equities 70% bonds - conservative

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Alternative - "Your bond allocation should roughly equal your age." -- Jack Bogle

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3. Never bear too much or too little risk

• The table to the right shows the dispersion of annual returns for US bills, treasury bonds, and stocks from 1926 -2012.
• The next two slides illustrate both the historical rewards and downside risks US markets have offered investors.
• The slide 7 table provides real returns of US stocks, US bonds, and US treasury bills over the past decade, half century, and full century.
• Slide 8 shows the downside risks of various stock/bond allocations as measured by the 1973 - 1974 bear markets.

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3. US real returns

The table below shows the historical real (after inflation) return rewards for investing in US markets.

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Source: Credit Suisse Yearbook 2013

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3. Downside risk

Expected downside risk for various stock/bond allocations. Investors choosing to increase their equity proportion, either through less conservative guidelines or a desire to increase return, should understand why they feel they have the need, ability, and willingness to take on the greater inherent risk.

4. Diversify

• Diversification is the practice of buying mutual funds that hold large market segments, as opposed to trying to pick individual stocks that may or may not outperform the market as a whole.
• While broad diversification guarantees average returns, this is not bad. In part, because of higher fees, most investors underperform the broad market indexes.
• Diversification also involves holding a cross section of investments whose performance does not correlate highly, e.g., stocks and bonds.

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Diversification approaches

Source: Credit Suisse Yearbook 2013

• Single-fund- holding a single fund that is in itself diversified . Many of these hold 3-4 funds which cover the entire market.

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Target Retirement Funds

• Multiple funds- selecting a few specific funds which cover the marketplace of investing.

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Three Fund Index Portfolio **

Core Four Portfolio **

Seven Fund "Coffeehouse Portfolio" **

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5. Never try to time the market

The performance record of individual investors reflects the difficulty of successfully timing market movements.

• John Bogle reports that over the twenty-five years between 1982 - 2007 the stock market index fund was providing an annual return of 12.3 percent while the average equity fund was earning an annual return of 10.0 percent. Meanwhile, the average fund investor was earning only 7.3 percent a year.¹

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• Ilia D. Dichev examined investor dollar weighted returns and found an annual difference of 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and an average 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. ²

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5. Never try to time the market

• Rather than attempting to time markets, investors are advised to devise investment portfolios according to their willingness, need, and ability to handle risk.

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• Create an asset allocation that includes high quality bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance the portfolio to maintain the desired risk level.

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• During the decade January 1996 through December 2005, an annually rebalanced portfolio provided lower volatility and, in this instance, higher return.¹

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Stocks represented by a Russell 3000 ® total stock market fund. Bonds represented by a Lehman U.S. aggregate total bond market fund.

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6. Use index funds when possible

Indexing advantages

• No overlap: It is almost inevitable that a portfolio of managed funds will have overlap. This is not a problem with properly selected index funds.
• No worry about underperforming a benchmark index: Many best performing managed funds later seriously underperform their benchmarks (U.S. Growth, Magellan, Legg Mason Value Trust, etc.).
• No worry about "asset bloat": This often causes large successful funds to underperform (Magellan).
• Less cash dilution: Index funds hold less cash than active funds.
• Less worry that a manager has "lost his touch": Index funds will continue to match the returns of the market.
• No manager changes: History tells us that the average manager leaves within five years. Index fund investors do not worry about manager changes.

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6. Use index funds when possible

Indexing advantages

• Tax-Efficiency: In taxable accounts, index funds are significantly more tax-efficient than most managed funds. It is after-tax return that counts.
• Low maintenance: Index funds are simple, predictable, and easy to understand, explain, and maintain.
• Peace of mind: Indexers know the averages are always working for them. The index investor has much less worry and more free time to spend with family and other more enjoyable endeavors.

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6. Use index funds when possible

Indexing advantages

• Low Costs: Index funds can have much lower costs than most actively managed funds.
• Diversification: The increased diversification of index funds results in lower risk. Baer & Ginsler ¹ did a study of Standard Deviation for actively managed funds vs. the total stock market over both 5- and 10-year periods. Their conclusion: "The returns of actively managed funds were 20% to 25% more volatile than the broad market."
• Consistency: Vanguard's Total Stock Market Index Fund (VTSAX) ranked among the top 25% of large-blend funds in just two of the past 10 years. Nevertheless, because of its consistency - only once falling below average - it outpaced 91% of all large-blend stocks after taxes.
• Continuation: Of 355 actively managed equity mutual funds around in 1974, less than half survive today. Indexers do not have to worry that their fund will disappear.
• No style drift: We know that asset allocation determines about 90% of the variation in portfolio performance. Managed fund allocations often change style.

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7. Keep costs low

• The difference between a mutual fund expense ratio of 0.15% and 1.50% might not seem like much, but the effect of the compounding over an investing lifetime is enormous.
• Investment costs can include front-end or back-end sales charges, and marketing fees (12b-1) in addition to fund expense ratios.
• The following slides demonstrate the corrosive action of sales charges and high fees on the long-term performance of a lump sum investment, as well as the benefits of reducing costs on a retirement fund.

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7. Keep costs low

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• Both funds assume an initial $10,000 investment and 8% annual growth. The time period is 30 years. The low-cost fund is no-load and has expenses of 0.2% per year. The high-cost fund has an initial 5.75% sales load, expenses of 2.0% per year, and a 0.25% 12b-1 fee.

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• The high-cost fund's initial value is $9,425.00 (10,000 - 5.75%). With annual expenses of 2.25% (growth of 5.75% = 8.00% - 2.0% - 0.25%), the resulting fund value at year 30 is $50,430.

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• The low-cost fund's initial value is: $10,000. With annual expenses of 0.2% (growth of 7.8% = 8.0 % - 0.20%), the resulting fund value at year 30 is $95,184.

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• The difference between these funds over 30 years is $44,753.

7. Keep costs low

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Results are simulated. The saving phase simulates a participant with a salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25, increasing by 0.5% per year to a maximum of 10% and with a 50% company matching contribution up to the first 6% of salary. In retirement, $63,750 (75% of final salary) is deducted at the beginning of each year. The blue-shaded area shows ending savings with an after cost investment return of 9% assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. Inflation is assumed to be a constant 3%. The tan-shaded area assumes 1% greater return each year due to reducing the costs of investment by 1%. All amounts are in present-day dollars.

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8. Minimize Taxes

Taxes on investment income directly reduce investor returns. Several strategies can be deployed to increase a portfolio's tax efficiency.

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• Take full advantage of tax-advantaged accounts such as 401(k)s and IRAs. These allow your money to grow, using the magic of compound interest, without a portion being removed every year to pay taxes.

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• In taxable accounts, look carefully at the tax efficiency of each holding.

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See also Bogleheads Principles: Understanding taxes for a series of slides detailing taxation.

Most Tax Efficient

Place Anywhere

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Assets

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Very Efficient

Tax-managed stock funds

Large-cap and Total-market index funds

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Efficient

Small cap and mid-cap index funds

Value index funds

Low yielding bonds or cash

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Moderately inefficient

Balanced funds

Most bonds

Active stock funds

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Very Inefficient

Real Estate or REIT funds

High turnover active funds

High Yield bonds

Least Tax Efficient

Place in Tax-Free

or Tax-Deferred

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9. Invest with simplicity

• "Simplicity is the master key to investment success." -- Jack Bogle

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• It is not necessary to own many funds to achieve effective diversification.

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• A simple portfolio has many advantages. It almost always lowers costs (including taxes), makes analysis easier, simplifies rebalancing, simplifies tax-preparation, reduces paperwork and record-keeping, and enables caregivers and heirs to easily take over the portfolio when necessary.

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• If your entire portfolio is in a tax-advantaged account, you can simplify by owning a single balanced index fund such as a target retirement fund or a fixed allocation fund, choosing one with a specified stock/bond ratio that satisfies your tolerance for risk.

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• A portfolio held by many Bogleheads forum members is the three-fund portfolio, which allocates investments among a U.S. Total stock market index fund, a Total International stock market index fund, and a U.S Total bond market index fund. (slide 21)

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• Vanguard recommends a four-fund portfolio for global diversification. (slide 22)

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• The "Coffeehouse Portfolio" recommended by Bill Schultheis is an example of a size and value tilted portfolio. (slide 23)

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Three-fund portfolio

Total Stock Market Index

Total International Index

Total Bond Index

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Four-fund portfolio

Total Stock Market Index

Total International Index

Total Bond Index

Total International Bond Index

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Coffeehouse portfolio

Large Blend 10%

Large Value 10%

Small Blend 10%

Small Value 10%

Total International 10%

REIT 10%

Intermediate Bond 40%

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10. Stay the course

"Stay the course. The secret to successful investing isn't forecasting or good stock or fund-picking. It is about making a plan, sticking to it, eliminating unnecessary risks, and keeping your costs low." - John Bogle, Pillar No. 10.

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• Once you have set long-term investment goals, established an asset allocation plan to meet them, and invested assets, it is essential to stick with your plan by maintaining a long-term perspective.
• This long-term perspective is often referred to as a buy-hold-and-rebalance approach.
• Investment professionals often counsel investors to commit their investment plans to a written statement.
• This written statement is referred to as an Investment Policy Statement (IPS). An IPS need not be overly complicated. An elegant example of a simple IPS is included in slide 27.

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10. Investment Policy Statement

An IPS often includes the following main topics:

• Financial account information
• Investment objectives, time horizon, risk tolerance
• Asset classes to be used and those to be avoided
• Asset allocation targets and rebalancing ranges
• Monitoring and control procedures

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An IPS should also be a flexible document in that it it accommodates change. Legitimate changes to an IPS include changes in an investor's life and fundamental changes in the investment landscape.

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Life changes include such things as marriage or divorce; birth of children or death of family members; changes in employment status; changes in health status ; aging. All of these changes can affect an individual's risk tolerance, and an IPS should allow for a reset of policy.

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Some examples of fundamental market changes include tax-law changes, the inception or deletion of retirement plan options, and the introduction of lower-cost investment options for asset classes.

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10. Investment Policy Statement (Example)

Investment Philosophy:

"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" -John C. Bogle

Asset Allocation:

Maintain overall 60% stock + 40% fixed-income allocation until home purchase to accommodate both short-term and long-term requirements. Assets should be diversified across major asset classes including domestic equity, international equity (20-25% of equities), conventional bonds of short to intermediate term, and TIPS (50% of fixed).

Funds & Accounts:

Use low-cost mutual funds - index funds preferably - that do not overlap and that provide maximum diversification across asset classes. Try to assume only market risk as far as possible. Try to shelter tax-inefficient funds in tax-advantaged accounts to reduce tax drag.

Target Allocation:

• VTSMX - Total Stock Market Fund 45% - Taxable account
• VGTSX - Total Int'l Market Fund 15% - Roth IRA
• VIPSX - TIPS Fund 20% - Traditional IRA
• IIBAX - Intermediate Bond Fund 20% - 401k
• VMMXX - Money Market fund (6 months' expenses) - Taxable account

Other considerations:

Automate future contributions wherever possible. Rebalance yearly. No market timing. Exact sub-allocations are not as important as maintaining the overall 60/40 stock/fixed allocation - no need to make things complex in order to meet sub-allocation targets.

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