Long-Term Investing

Section 1

A). Summary of Chapter 1:

This chapter’s main focus is on long-term investing. The chapter starts by talking about how economy is very similar to the seasons that a garden experiences on Earth.  For example, a flower grows and flourishes during the spring, come winter though it goes dormant, but so long as its roots are never severed, it will grow and flourish once again in the spring. Overall, the economy has remained stable over the long run, it may face more times of negative growth such as the Great Depression, but eventually the economy balances itself and starts to grow again. Bogle then introduces the concepts of stock market returns and risk, where he explains how although stock market real rates of return have historically been steady over long periods of time, stocks are still very volatile and always will be. Stocks are volatile because their rate of return has been subject to considerable variations from year to year and always will be subject to these variations. Chapter 1 also discusses bond market returns and risk which are very different from stock market returns and risk.  Bond market returns have historically been very inconsistent in comparison to stock market returns, but bonds have come with less risk than stocks in general. To end the chapter, Bogle recommends a few rules that everyone should follow when investing long term. His rules include, investing being necessary, time being your friend, not investing on impulse, stick to simplicity when investing, and staying the course through your investments.

B). Summary of Chapter 2:

Chapter 2 is based on the nature of returns.  Bogle theorizes that three variables, the dividend yield at initial investment, the subsequent rate of growth in earnings, and the change in the price to earnings ratio during the investment period, determine the stock market returns over the long-run.  His theory is based on Occam’s Razor, which is an insight that the simpler an explanation is, the more likely it is to be correct.  From the sum of these three factors, you can explain almost all of the stock market’s returns over extended holding periods. Analyzing the contributions that the three factors make to the total return, allows for considerations of future returns to occur, as this arithmetic is the basis of historically analyzing past returns.  Bogle explains that no matter how compelling past returns are, expecting those returns to repeat themselves leads expectations down the wrong path.  Anything can happen in financial markets, but the chapter strives to make the reader understand the major forces that drive market returns because they are worth knowing and understanding.  Key points in this chapter were to invest with common sense and intelligence, always having some significant portion of your assets allocated in stocks and bonds, and engaging in rational and enlightened discourse when you consider the future and forecasting.

C). Summary of Chapter 3:

This chapter’s main focus is on asset allocation. Similar to the simplicity of the garden analogy from chapter 1, asset allocation is just as simplistic.  We divide or portfolios by following a simple logic of diversification as we invest in the financial markets with faith.  Almost all investors primarily choose to invest in common stocks, cash reserves and bonds in order to diversify their investment portfolios.  Each of these investments have varying risks with stocks being the most volatile security, bonds less volatile, and the cash reserves being inviolable.  Over the last 25 years, investors have essentially universally accepted the modern portfolio theory, which is based on creating investment portfolios that look for returns which optimize an investor’s willingness to assume risk.  The most basic concept of this theory is that the portfolio is comprised of all liquid assets.  Bogle’s investment strategy in regard to asset allocation is to have two0thirds of a portfolio invested into stocks, and the remaining one-third in bonds.  Along with his asset allocation guidelines, he also has four dimensions of investing, return, risk, cost, and time.  He believes each of these dimensions are a key force to consider when investing, in order to be successful.  In relation to these dimensions, the world has argued for years on whether cost of asset allocation was more important when it came to performance.  The mutual fund industry believes asset allocation is by far more important than cost.  From this argument, the question of whether performance was determined by asset allocation or by cost was created.  After various studies and discussions, common sense and data gave us the answer to the question, with it being that both asset allocation and cost were equally important in determining financial performance.

D). Summary of Chapter 4:

Chapter 4 focusses on simplicity when it comes to investing. Since the creation of the World Wide Web, the world of investing has changed drastically because of the mass exodus of information available.  Investors are bombarded with investment information, complex analyses, and investors are now asking mutual fund managers about the fund’s Sharpe ratio, or its alpha.  Even with this absurd amount of information that many investors assume will enhance their returns by using more complex information, it has not exactly translated into better returns over time. When it comes to simplicity, Bogle has eight non-complex rules that he believes helps investors to make intelligent fund selections for investing. Selecting low-cost funds, consider carefully the added costs of advice, do not overrate past fund performance, using past performance to determine consistency and risk, beware of stars, beware of asset size, do not own too many funds, and buy your fund portfolio and hold it, are the eight rules Bogle has.  All these rules are very simple and self-explanatory, with the intention of helping investors succeed.  No single rule is more important than the other, because the most important rule is to maintain simplicity in a complex world.  Each of the eight rules are designed to help investors select portfolios of funds that may give various advantages that have helped to elevate the index fund (paradigm of simplicity) to its current success and acceptance among investors. Although Bogle’s approach to investing is a simple concept, it is not an easy one to implement.  

E). Summary of Chapter 5:

This chapter’s main focus point is on indexing. An index fund is an unlikely hero to the typical investor, as it is no more than a broadly diversified portfolio, ran at incredibly low costs, and without the talents of a brilliant portfolio manager.  Index funds simply buy and hold securities from a certain index, in proportion to their weight within the index.  The concept of index fund is very simple, a concept that started slow in terms of acceptance by investors, but now it is the standard that rules debates involving investment strategy, fund selection and asset allocation.  The success that indexing has had over the last few years has been due to the recognition of acquiring and holding a broadly diversified portfolio full of large, highly-graded stocks at extremely low costs is a successful strategy and productive.  Regardless of what the future may hold, long-term investors who choose the index strategy based on its merit, are very unlikely to be disappointed when receiving the results of their investments, in comparison to short-term investors expecting a continuation of high historical returns shown by the S&P 500 Index.  It is important to clarify that the S&P 500 is not the market, instead it only represents 75% of the market that is represented by large-cap stocks, and excludes medium and small market cap stocks.  Even though the S&P 500 does not represent the entirety of the market, it is still the principal measurement standard that most mutual funds use.  What started as a major controversy, is now one of the major investment strategies utilized today, with nearly all major no-load fund complexes offering index funds.  Even major stock brokerage firms are ow offering index funds on a no-load basis as well.  The index fund is here for the long-run and is now the standard of investment return for the mutual fund industry.