Bogle: Don't Forget These Lessons Next Time

Investing legend John Bogle, founder of the Vanguard Group of Mutual Funds, writes in a guest column for The Wall Street Journal that investors continually ignore lessons of the past, which cost many dearly last year. Bogle offers six such lessons that we should not forget moving forward:

Beware of market forecasts, even by experts: At the start of 2008, Bogle says strategists from Wall Street’s 12 major firms forecast, on average, a year-end closing value of 1,640 for the S&P 500 and year-end earnings of $97 per share for the index. The S&P in reality closed at 903, with estimated earnings of $50. “Ignore the forecasts of inevitably bullish strategists,” Bogle says. “Bearish strategists on Wall Street’s payroll don’t survive for long.”

Never underrate the importance of asset allocation: Bogle says that investors should hold more than just common stocks, and shouldn’t expect historical stock returns to be a sound guide to future returns. He advises keeping some high-grade short- and intermediate-term bonds in your portfolio, and says a good guide is to have the percentage of your portfolio in bonds be equal to your age. “Consider not only the probabilities of future returns on stocks,” he says, “but the consequences if you are wrong.”

Mutual funds with superior performance records often falter: This was made clear by the recent missteps of the likes of Ken Heebner and Bill Miller. “Chasing past performance is all too often a loser’s game,” Bogle writes. “Managers of funds seeking market-beating returns should make it clear to investors that they must be prepared to trail the market — perhaps substantially — in at least one year of every three.”

Owning the market remains the strategy of choice: Bogle, long a proponent of index funds, reiterates his stance. Actively managed mutual funds can charge fees that are significantly more than index funds, be they stock index funds or bond index funds.”In sum, active management strategies as a group lose because they are expensive,” he says. “Passive indexing strategies win because they are cheap.”

Look before you leap into alternative asset classes: Investors flocked to commodities and foreign stocks in recent years, not only chasing performance but also doing so under the impression that these investments were “non-correlated assets” and “reducing volatility risk”, Bogle notes. The huge plunge in international stocks and commodities alongside U.S. stocks showed that notion was wrong. Says Bogle: “Always keep in mind: When the investment grass looks greener on the other side of the fence, look twice before you leap.”

Beware of financial innovation: “Most of it is designed to enrich the innovators, not investors,” Bogle says, noting all of the industry employees who made big bucks from fees involved in the mortgage-backed securities that led to huge losses for investors. “Our financial system is driven by a giant marketing machine in which the interests of sellers directly conflict with the interests of buyers,” Bogle writes. “The sellers, having (as ever) the information advantage, nearly always win.”