Improving Your Finances What the Bogleheads Know for Sure

By Christine Benz | 03-03-10 | 06:00 AM | E-mail Article

If you’ve frequented the “Discuss” area of Morningstar.com, chances are you know the name Taylor Larimore. Taylor, a former IRS officer and retired chief of the Small Business Association’s finance division in South Florida, has contributed more than 24,000 posts to the Morningstar.com discussion boards for more than a decade, and also posts on a related site, http://www.bogleheads.org. He is also co-author of two Bogleheads’ books: The Bogleheads’ Guide to Investing (Wiley, 2007) and The Bogleheads’ Guide to Retirement Planning (Wiley, 2009).

I recently caught up with Taylor to discuss his investment philosophy and his view that the simplest investment plans are usually the most effective.

1. What was the genesis of the Vanguard Diehards forum on

Morningstar.com?

I have long been a student of mutual fund investing, and Morningstar is by far the best source of reliable mutual fund information. It is where I go to learn. When Morningstar started its first public forum in 1997, I began asking questions on the John Rekenthaler Forum. John is now Morningstar’s vice president of research and was a wonderful source of information and sound advice. For some reason, a large percentage of the questions (and answers) on the site were from Vanguard investors. Several of us asked the forum administrator at that time, Jenny Barrie, to start a Vanguard Forum. We argued so long and loudly that Morningstar gave us its first company forum and that’s why Morningstar called it “Vanguard Diehards.” I posted in the first conversation in March 1998.

2. You’re a big fan of simplicity when it comes to investing, and that comes through loud and clear in the two Bogleheads’ books. What are some key pieces of advice for those wishing to simplify their investment lives?

I have been investing more than 50 years. Most of those years I spent constructing complex portfolios and often using market-timing strategies–all in an attempt to beat the market. Well, guess what? Despite all the time and effort I was spending trying to beat the market–the market was beating me–especially after taxes. I’ve now come to realize that the best portfolios for ordinary investors are low-cost and simple to understand and maintain. Most unbiased investing experts agree. Index funds are a great starting point for those looking to simplify their investment lives. Jack Bogle introduced the first index fund for retail investors in 1976–the Vanguard S&P 500 Index Fund (VFINX). That fund represents about 75% of the U.S. stock market in market value. Fidelity called his fund, “Bogle’s Folly,” but it is interesting to learn what’s happened. In the 40-year period ending December 2008, $10,000 invested in Vanguard’s S&P Index Fund would have grown to $346,117. During the same period the average managed domestic equity fund increased to$201,513–a huge difference.

The Arithmetic of Active Management by Nobel Laureate William Sharpe explains why an average actively managed fund must have a lower return than the average index fund. Other significant advantages of index funds are less volatility, neverbelow-average returns, no manager changes, no overlap, no style drift, tax efficiency, and peace of mind leaving more time for family and other endeavors.

Total market index funds make it even easier to build and oversee a simple and effective portfolio. Vanguard Total Bond Market Index Fund (VBMFX) was launched in 1986, followed by Total Stock Market Index Fund (VTSMX) in 1992 and Total International Stock Index Fund (VGTSX) in 1996. Using just these three funds, representing more than 10,000 individual securities, today’s investor can achieve market returns (less costs) with diversification that was unheard of when I started investing. A second key to investment simplicity is to stay the course. Once we have decided on our asset allocation, it is important to do nothing (except rebalance). This is much harder than it sounds because Wall Street’s marketing machine, aided by the media, is constantly urging us to take action. Bogleheads call this “investment pornography.” Mr. Bogle wrote in Common Sense on Mutual Funds: “‘Stay the course.’ It is the most important single piece of investment wisdom I can give to you.” Other investing experts agree.

3. Your latest book, The Bogleheads’ Guide to Retirement Planning, was a collaborative effort with several other longtime Bogleheads. What are some of the key pieces of advice you would give to retirees attempting to navigate the current environment of very low yields?

Safe investment options are currently limited to low returns. Higher return nearly always means higher risk. In our retirement account, my wife, Pat, and I currently hold 50% in Vanguard Total Bond Market Index Fund and 50% in Vanguard Inflation-Protected Securities Fund (VIPSX). The worst annual return for either fund was negative 2.6% in 2004. We can live with that. Another option, especially for older retirees, is a single-premium immediate annuity. It is the only type of annuity I like, but a SPIA will provide the largest guaranteed lifetime income of any investment. We purchased two SPIAs when we were in our late 70s. It was comforting to have their steady income during the recent bear market and to know that we won’t run out of money before running out of life. I think the key piece of advice for most retirees is to do what is necessary to keep what they’ve accumulated. This usually means a large allocation to relatively safe investments such as money market funds, CDs, and good-quality bonds. I like Mr. Bogle’s rule that our allocation to bonds should about equal our age. Stocks are very unpredictable. The Dow plunged 89% during my lifetime. Retirees must resistthe urge to seek higher returns if it means taking unnecessary risk.

4. You once ran a contest on Morningstar.com to illustrate the futility of

timing the market. What would you say to individual investors and advisors timing the market. What would you say to individual investors and advisors who employ more tactical approaches?

I would repeat what I learned in your Morningstar Course 106: “We’re not keen on market-timing. It just doesn’t work.” Every reliable study I’ve seen arrives at this same conclusion. Mr. Bogle wrote in his great book, Common Sense on Mutual Funds: “After nearly fifty years in this business, I do not know of anybody who has done market timing successfully and consistently. I don’t even know anybody who knows anybody who as done it successfully and consistently.” It seems to be human nature to think we can forecast the stock market. To demonstrate how difficult it is, at the beginning of 2001, I started a Boglehead Contest on the Morningstar Diehard forum. I asked each Boglehead to guess what the U.S. stock market return would be at year-end. The average Boglehead forecast a 6% gain. Instead, the market lost 11%. Last year we had 282 Bogleheads register. Their year-end forecasts for the S&P 500 Index, made in January 2009, ranged all the way from a decline of 40% to a gain of 27%. No one really knows what the securities markets will do tomorrow, next year, or the next 10 years. Ten years ago virtually no one was forecasting that bonds would outperform stocks 10 years later.

I think the best strategy is to spend time creating a sensible, long-term asset allocation plan, then stick with it. My friend Bill Bernstein wrote: “If over the past 10 or 20 years, you had simply held a portfolio consisting of one quarter each of indexes of large U.S. stocks, small U.S. stocks, foreign stocks, and high-quality U.S. bonds, you would have beaten over 90% of all professional money managers and with considerably less risk.”

5. If you could sum up what you have learned during a lifetime of investing experience, what would you say?

My advice to be a successful investor is this: Save regularly, develop a personal asset-allocation plan, use a few broad market index funds, keep costs low (including taxes), avoid mistakes, strive for simplicity, and stay the course.