Thu, 13 Oct 2011
The Vanguard founder and former chairman on the average investor's odds with private equity, hedge funds, and commodities, including gold.
Benz: There has been a lot of interest in alternatives, retail investors embracing alternative products. You have done some work looking specifically at college endowments, many of which have been quite heavy on alternatives. What have you found about their performance and what does that say about retail investors' ability to jockey among these investments?
Bogle: Well, it's a curious thing: A couple of weeks ago, I gave a talk to endowment fund managers, some 300 or 400 strong down in Washington. And it happens that, for the common fund, 15 years ago, pretty much exactly, I had given some investment advice, how I would run an endowment fund, and that's all in their book along with other comments by Sir John Templeton and Michael Price and Barton Biggs, 10 or 12 of Peter Bernstein--all had ideas about how they would manage their college endowment funds. And I said, look, keep it simple: go 50% stocks, 50% bonds, both cases indexed, and that produced a return of about 7%. The average college endowment fund had a return of 7.2%.
There are two caveats on that. One, the average college endowment fund was about 30% more volatile. As a result, for example, in 2008, my little package went down I think it was 10%, and the average college endowment fund went down 20%. That's a big difference in volatility. So, I was very comfortable of giving them basically the markets return and not doing anything else.
However, that number is raised way up by the huge success that Yale, David Swenson, Princeton, Harvard, to some extent Duke ... who have been using a lot of alternatives with great success. They would, and in particular David Swensen would tell you, don't you do that yourself, because you can't, we can. We've got all the staff. We've got an infinite time horizon, think about that. We have no tax liabilities, and we can do it, and you can't, and they all had very good years. 21% gain last year I think, which was not that much more than the S&P 500. That would have been a lot more than my 50-50 portfolio because of the bond position.
So, I would tell people, don't try and do that. Watch out for alternatives. Now there are two kinds of alternatives. When you get to private equity, David Swensen himself says, look, private equity on the record does about the same as the S&P 500 on average. So you've got to do a lot better than that. Same volatility, there is a lot of high jinks played in the private equity game, and a lot of grabbing from the cookie jar by the managers, and I just don't think that's a good idea for the average investor to do.
The other part of it is hedge funds. And hedge funds, it's kind of interesting, because they have had an era ending in 2007 in which their returns were quite good, but not any higher than, for example, the old Wellington Fund, our Vanguard Wellington Fund, about the same returns with more risk and much less tax efficiency. So, there's nothing really write home about from them. And now in retrospect, we are looking at things like, how much of those past hedge fund returns were created by people doing illicit market timing in mutual funds? How much of those returns were created by people who were on their way to jail for insider trading? How can you rely on the past records of these hedge funds? I'd say there are certainly some good ones. I'd say they are very difficult to identify, and they are really beyond the ability or reach of the average person, just because of the minimums that would be involved.
Now people seem to talk about funds of hedge funds. That's a another layer of cost, and I think that's just a loser's game. So I'd do the stretch straight and narrow.
Another alternative, of course, commodities, and I've been saying this for a long time that the problem with commodities is they have no internal rate of return. When you buy a commodity, gold, wheat, pork bellies I guess are still around, you're betting that you can sell it to somebody for more than you paid for it--the ultimate speculation. Stocks get bailed out in the long run by earnings growth and dividend yield. Bonds get bailed out in the long run by interest rates, interest yields. But there's nothing to bail out commodities. They are a rank speculation. I don't think for most of us it's a good idea to speculate. Now I look at gold, and it keeps going up, and I think, "Oh my gosh, you're wrong again, Bogle," and that's always possible, of course.
Benz: It's been going down recently, though.
Bogle: Yeah, a little bit, a little bit. And I just don't know how to deal with that. I have been tempted to put maybe 1% of my portfolio or 2% into gold, but my whole life tells me, and my investment experience tells me, when you're tempted to do something, don't.
Benz: How about inflation, though? I know that people have gravitated to commodities to try to add a layer of inflation protection to their portfolios. Do you think there's a better way to do it? Is it TIPS alone?
Bogle: Inflation is kind of a funny thing. Commodities, of course, cannot protect you against inflation over the long term. I mean I have in one of my books said the wholesale commodity price index in London at the end of ... World War I was at the same level it was at the time of the Great Fire in London in 1666 or something like that. That's a long time for no change, and so beware of that.
There's no rate of return. Basically commodity prices are going to have to grow at 3% or 4% or 5% or 6% year after year, and it doesn't do that. If you put the price of gold on a long-term chart, it looks terrible. You can look at it for 200 years. It's never produced anything except price appreciation, mostly in great fits and starts--the late 1970s, obviously the ... first decade of the 2000s.
And so, I don't like unpredictability. And the focus is always on what's done well, that we investors have. Our neighbor is doing better. He owned gold or he owned growth stocks, or value stocks did nothing. That was true at the end of the '90s. And the moment the temptation gets to its highest level, that's the moment when people start to think I've got to change now, and that's the worst time to do it. So I'm still a "stay the course" person. Own the stock market, own the bond market, as modified to meet your needs, and don't peek. One of the greatest rules for investing ever made…
Benz: Don't peek at what your neighbor is doing or saying he's doing.
Bogle: Don't even peek at your own account, don't open those 401(k) statements. If you don't look at your 401(k) statement--this sounds outrageous but it's true--for 45 years, you start when you're 20 and you don't open a single statement for the next 45 years, when you open that statement the day you retire, you are going to go into a dead faint of amazement about how much money you've accumulated.
Benz: Just using that hands-off approach.
Bogle: Yeah, but if you watch those fits and starts, they are just reflections of the stock market enthusiasms, basically, and as I said in yet another one of my books, it turns out that the stock market is a giant distraction to the business of investing. Stocks don't produce anything. They are means of owning companies who produce something. They are once removed from the reality. And so if people would just get their arms around investing and stop speculating, they would definitely accumulate much, much greater.