Morningstar Podcast - Jack Bogle on Market Returns, Indexing, International Stocks & Costs

Bogle's framework: 'Reality of stock market is fundamental return - dividend yield plus earnings growth of companies - drives long-term return. Only thing that gets in the way short-term is speculative return.' Current math: Dividend yield about 1.8%, future earnings growth around 5%, maybe better this/next year with tax cut. 'Dividend yield 2% and 5% is 7% - that's the investment return.' But P/E ratio likely to decline taking '1.5% off that 7% return which would be 5.5% return on stocks.' Normally uses 4% but '4-5% range for stocks.' Bonds simpler: 'Only one driving factor in long run - current level of interest rates.' Using 50% 30-year Treasury (3%) and 50% corporate (4.25%) gives about 3.8%, rounds to 4%. Combined 4% return has huge implications: 'At 12% a year market doubles in 6 years. At 5% a year market doubles in approximately 15 years.' Caveat: 'Point of this is not accuracy - anyone tells you they know how to do it shouldn't be talking to you.'

Devastating cost analysis: 'When you look at combined market return of stocks and bonds together, let's call it 4%... Average mutual fund has expenses that come to pretty close to 2%.' Not just expense ratio (actively managed funds about 0.75%), but also 'sales loads for a lot of funds' plus 'internal portfolio transaction charges you don't see but they're there.' Fund managers 'turn their portfolios over with fury - active managers turnover rate something like 100%.' Convention measures 'lower of purchases or sales' but that 'ignores that cost is both sides of the transaction not one.' So 2% cost takes half the 4% return. Then 'take inflation out - assume we're lucky to get 2% inflation - four percent off that return.' Bottom line: 'We can't do anything about inflation but we can do something about fund cost: keep them low period. Which means index funds should be at the top of your list.'

Bogle's empirical evidence: 1975 study for Board covered 'previous 35 years of large cap funds compared to S&P index - S&P index outperformed by 1.6% a year.' Updated study through 2015 covering another 35 years: 'Difference was 1.6% in favor of index fund.' Why? 'Cost of mutual fund management is about 1.6%... It's telling us average manager is average before costs - how else can it be? It's very competitive business, very smart people competing with one another, hard to get an edge.' Even at 45% of fund industry, 'very little evidence that indexing has changed the nature of the market.' Myth debunking: 'If market is less efficient people will say active managers can do well - stock pickers market. No, because if active manager A beats the market, active manager B will lose to the market.' On stock pickers market: 'Never saw a phrase with such acceptance that meant so little. Sure there's a stock pickers market but every stock that's picked is unpicked by somebody else. Everybody that buys is buying from a seller. Simplest thing in the world people don't seem to get - we're all consigned to average as a group.'

Bogle's contrarian view even within Vanguard: 'I'm just a great believer in US portfolio because we are the most entrepreneurial nation, we've got the soundest institutions financial and otherwise or have had in the past, governance is pretty solid in the past at least, and a well-diversified economy.' Key argument: 'For US corporations about half of their revenues and half of their earnings come from abroad anyway. It's not as if we're America first or America only - the entire world economy is integrated.' On undervaluation question: 'Fact that they're undervalued may mean that they're undervalued because they're riskier which I think is at least importantly the case.' His allocation: 'I have zero percent in non-US. I say you don't need to have non-US but if you do, limited to 20%.' Criticizes common allocations: 'A lot of portfolios now at 25%, 35%, 45% in non-US securities and I think that's just too much.' Emerging markets concern: 'Around 20% of the non-US index, are very risky, very interest-rate sensitive, governmentally not strong or maybe capable of tipping over.'