Bogle Says "Follow Ben Franklin"

John C. Bogle - his nickname is Jack - is an investing legend... he founded The Vanguard Group in 1975, created the first ever Index Fund and has grown Vanguard into one of the largest asset managers in the world - Vanguard now manages over $2 trillion, that's phenomenal!
Bogle recently wrote a guest article for CNBC titled "Jack Bogle's advice for a rocky market: Follow Ben Franklin"... and this article is very timely because we've already had a rough start to the year with the Dow down about 4.5% in January and high volatility in the first week of February... and research shows that January performance often sets the tone for the rest of the year... so let's see what Bogle's advice is for a potentially rocky 2014... it's actually pretty simple and easy to implement.
Bogle invokes Benjamin Franklin and extols his investment wisdom... the wisdom--that simplicity trumps complexity in the stock market. And Bogle begins with what he calls Franklin's acute understanding of the miracle of compound interest. In 1794, Franklin bequeathed a thousand dollars each to his native city of Boston and his adopted city of Philadelphia, to be kept in an interest bearing account over a period of 200 years... good ol' Ben assumed a 5% average annual rate of interest and surmised that the $1,000 would grow to about $17.3 million in 200 years. Unfortunately, because of tough times during those two hundred years, it was difficult for Boston and Philadelphia to get a good 5% interest rate each year so Boston's fund grew to about $5 million by 1994 while Philadelphia's fund grew to less than half that amount - $2.25 million. And even though these amounts underperformed dear Ben's calculations, they still handsomely showed the explosive mix of... rate-of-return and time... which is the magic of compounding!
But, of course, 200 years is impractical for most of us saving for retirement, so Bogle focuses on a 65-year time horizon that assumes a 45-year working career from ages 20 to 65, and 20 years in retirement... and says $1,000 invested at age 20,
compounded at about an 8% average annual rate of return, could grow to almost $150,000 through simple compounding... but before we get our hopes up, Bogle hastens to add that in reality, fees and commissions would eat up about 2.5%... and reduce your actual rate of return to about 5.5%... so that $1,000 will grow to only about $32,500 - not $150,000 - that's a whopping 80% reduction in wealth accumulation because of what Bogle calls the tyranny of compounding costs that significantly overcome the magic of compounding.
So while many investors take fees and expenses in stride, they do not realize that the reduction in effective annual rates of return take a really huge bite out of their total investment gains.
Think of it this way - you put up all the capital, but money managers, marketers of investment products and stockbrokers - who put up zero capital and assume zero percent risk - receive fully 80% of the return... a shift from owners' capitalism to managers' capitalism that devastated investor returns.
So the way to build wealth is to avoid the high cost, high turnover tactics that characterize our financial system... and, instead, to rely more on the magic of compounding... perhaps through low-cost index funds... and, Bogle says, while the interests of a business are served by the saying "Don't just stand there. Do something!", the interests of an investor are served by the exact opposite... "Don't do something. Just stand there!" and let time do its magic.
Now from my point of view, having been an investment advisor and counsellor for 32 years, some extra fees are worth paying for. Yes, if we were all Rip Van Winkle and fell asleep for 20 years, then Jack is right. You'll wake up one day and see that your savings are worth a whole-lot more. But the reality is that life intervenes. Life throws us curve balls and not all of us have the ability to leave our savings alone if a crisis pops up in our lives. For example, the loss of a job can occur right at a time when your investments are worth less on paper. The consequence of spending your savings at exactly the wrong moment could be devastating. So the need for good advice can significantly increase your chance of surviving and thriving in the future. Even the Cities of Boston and Philadelphia incurred problems preventing them from earning the full 5% Ben Franklin envisioned.
The other factor Jack doesn't take into account is the difficulty most people have of just standing there and doing nothing! Human behavior, being what it is, pushes us to follow the crowd and buy when others are buying no matter how high the price and sell when others are selling, no matter how low. A good advisor will help you fight your impulses which should result in a better outcome.
Of course it is important to pay a reasonable amount for these services. Like everything else we buy, we should attempt to get the best price for a given service, always keeping in mind that it's not just what you spend, but what you get for the money you are spending.
So Ben was right... , but even he didn't see how hard it would be to get a simple 5% return over a long period of time. And I'm sure the reasons for the lower return were closer to the "life intervenes" idea that the "high fees" idea.
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