Jack Bogle, founder of Vanguard Group.
I’ve come up against a bit of criticism recently from some investors who call themselves Bogleheads, indicating they are true followers of the late Jack Bogle, longtime head of the Vanguard Group.
I knew Bogle and interviewed him many times. I admire him, and I think his work amounts to an immeasurable help to millions of individual investors. He and I totally agreed that neither we nor anyone else could know in advance how any investment will do in the future.
We shared a lot of other basic beliefs:
• Investors should diversify, especially in equities.
• Wall Street very often charges too much for services that can be of dubious value.
• Low-cost, passively managed index funds with relatively low turnover (hence lower taxes) should be among an investor’s best friends.
• Market timing leads to trouble more often than not. The same goes for owning individual stocks.
• Investors should aim for achieving the returns of the entire stock market.
• A few low-cost mutual funds can give investors most if not all of what they need.
Everything I recommend can be accomplished at relatively low cost using Vanguard funds. In the later years of his life, Bogle advocated owning just three index funds: One for U.S. stocks VTI, +0.04%, one for international stocks VXUS, -0.70%, and one for bonds BND, +0.13%.
He believed each of the stock funds should own a portfolio that includes large-cap stocks and small-cap stocks, value stocks and growth stocks. Bogle was highly trusted for telling the truth in an industry that doesn’t have a stellar reputation for truth-telling.
He taught, rightly so, that equity funds that follow these guidelines are very likely to deliver long-term returns in the top 10% of their peers.
He also understood that investors could achieve results like that only if they stayed the course through thick and thin, which I believe dedicated Bogleheads will do well.
Hence my message to Bogleheads: You’re right.
Although my views and Bogle’s diverged on one fundamental point, neither of us was ready to accuse the other of misleading investors. So let’s get to where he and I part company.
Perhaps it boils down to this: I think his specific recommendations can be improved upon.
Bogle believed in “total market” indexes based on the capitalizations of the companies in each index. I, on the other hand, believe investors are likely to do better when they own equal parts of four major asset classes: large-cap blend stocks (represented by the S&P 500 SPX, -0.04% ), large-cap value stocks, small-cap blend stocks, and small-cap value stocks.
In the S&P 500, the stocks of giant companies like Microsoft MSFT, +0.11%, Apple AAPL, -0.62%, and Facebook FB, +1.14% have vastly more influence than much smaller companies in the index, companies like H&R Block HRB, +0.23%, Nordstrom JWN, -2.04%, and Harley-Davidson HOG, -1.30%, to name three examples.
(Between them, Microsoft, Apple, and Facebook account for 11.8% of the S&P 500; the three smaller companies I mentioned account for less than one-tenth of 1% of the index.)
To Bogle, that was not a problem. He believed that a capitalization-weighted index like the S&P 500 or the Total Market Index is sufficient to capture a nation’s stock market.
I think investors can do better.
The U.S. stock market is made up of large-cap stocks and small-cap stocks, value stocks and growth stocks. Each of these asset classes can (and often does) move up and down independently of the others.
There’s no disputing that small companies have higher historical long-term returns than giant companies. Yet the returns of those companies have very little effect on the Total Market Index, and investors in that index don’t get much benefit from the higher long-term returns of small-cap and value stocks.
Bogle and I agreed on that. Naturally, he was completely aware of the favorable historical returns of small-cap stocks and value stocks.
When I interviewed him in his office in 2017, I outlined a four-fund approach to the U.S. stock market that historically has often — though not always — turned in better performance than the Total Stock Market Index.
He understood completely. But he told me that, despite their favorable long-term returns, small-cap indexes were too risky for most investors.
He was not referring to the statistical risk of loss, but to a psychological risk: That a portfolio that’s very different from widely followed indexes like the S&P 500 will “spook” investors and lead them to sell when they should hang on. He felt strongly that most investors need a portfolio that has very little tracking error with the giant S&P 500 index.
To him, that concern led straight to a total market index fund, which nominally includes value stocks and small-cap stocks — but not enough to make a meaningful difference in return.
In the U.S. stock market, the returns and risks of the “total market” are nearly identical to those of the S&P 500 index.
Over the past 10 years, the Vanguard 500 Index Fund Admiral Shares returned 14.32%, compared with 14.44% for the Vanguard Total Stock Market Index Fund Admiral Shares.
Bogle’s concern is undoubtedly valid for many investors. But I believe in education enough to think investors who understand the facts can use their knowledge of history to keep the faith through thick and thin while they seek the likely higher rewards from straying from the total-market-index fold.
By the way, as I told Rick Ferri in a recent interview for his podcast Bogleheads on Investing, my views on small-cap and value investing are not original.
They are based on the work of two University of Chicago professors, Eugene Fama and Kenneth French. In 2013, Fama received Nobel Memorial Prize in Economic Sciences. French is now a professor at Dartmouth College.
Neither Jack Bogle’s approach nor mine is wrong. But they might be right for different kinds of investors.
Bogle’s recommendations seem well suited for people who want investing to be simple, with only one or two equity funds. People who want funds they can trust, recommended by somebody they can trust. Certainly, investors who are close to retirement or already retired should invest in a way that gives a strong sense of security.
My recommendations for portfolios of four funds and two funds seem appropriate for younger investors and those who have taken the time to understand the extra premium that should come with adding value and small cap — and who are willing to take a little more time to manage their portfolios.
Bogle and I both believe investors should do their best to control the things they can control, and leave the rest to fate.
You’ll find more comments and insight in my latest podcast, “The big payoff for asset class diversification.”
Richard Buck contributed to this article.