Whilst Warren's performance is unimpeachable and he is richer than just about everyone except for Bill Gates and more modest than Mother Teresa you have to wonder how relevant his investment style is to your average retail investor.
My anachronistic view is that it is completely irrelevant because Warren is Warren and most other people aren't. But there is another elderly investment superstar in the US whose style and legacy is arguably more relevant to retail investors worldwide than Buffett and that person is John Bogle, founder of the Vanguard Group.
Many people won't have heard of John Bogle (JB) but like Warren Buffett he is modest, successful and talks a lot of sense accumulated over his almost ninety years.
Bogle's biggest claim to fame is that he invented the world's first passively managed index fund back in 1976. He started off with hardly any funds under management and today Vanguard is either the biggest or second biggest fund manager in the world with around $3 trillion under management.
JB was interviewed a couple of years back and a summary of his insights into investment matters was published in the June 2013 edition of the CFA Institute Conference proceedings.
But before we look at that interview let's see where he is coming from.
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He grew up in the Great Depression and his family lived with his grandparents for a while. He recalls each month that his parent received notices from a finance company demanding payments of the family's debts. JB has worked since he was almost 9 years old and prior to completing an undergraduate degree at Princeton he was a waiter, a post office clerk, a soda fountain operator and even worked setting up pins in a bowling alley for six hours a day.
Clearly Bogle knows the value of a dollar and that is probably why Vanguard runs the lowest cost funds in the world.
In the interview the first point Bogle makes is that returns from the stock market can be considered to have two components; an investment return and a speculative return. He defines investment return as the dividend yield at the beginning plus the subsequent rate of earnings growth.
This is just the standard Gordon Growth model. But he defines speculative return as the impact of changes in the value that investors put on those earnings (the price to earnings multiple) during that period. The total of these two returns is the total return on stocks.
Although he doesn't say it, what Bogle is doing here is explaining to investors that dividend and earnings growth are what drives returns. So the stock market is not crazy, not driven by speculators but reflects reality ... over the long term. He points out that in one decade speculative return may be positive but normally in the following decade speculative return is negative.
He then says that dividends have accounted for almost fifty per cent of the long term return on shares and criticises managed funds because very few highlight the yield of their funds. The reason for this is that in many managed funds, particularly those of international shares, much of the dividend income goes in management fees.
Once you add in transaction costs, platform fees, custodial fees, monitoring fees and goodness knows what else the dividend income from international shares is usually zero. And that is before tax.
So JB's first two points are that stockmarkets in aggregate can get a bit illogical in the short term but this is usually corrected reasonably quickly and that dividends are critical to returns.... too important to lose them all in annual fees.
Next up JB gives his long term forecast for the US stock and bond markets. First up is shares and he says the dividend is 2 per cent and long term earnings growth is 5 per cent so the investment return is likely to be 7 per cent.
He guesses that the speculative return will be zero because stock looks fair value at present. JB says the long term return from bonds is just as easy to forecast as it is just the yield to maturity ... about 2.2 per cent at present for 10 year US governments and whilst he thinks bonds are expensive he adds that "bonds are the optimal risk reducing component of an investor's portfolio".
He then says he is sceptical of the alternative asset classes currently being promoted to investors on the basis that they have the diversification benefits of bonds with higher returns. This is like having your cake and eating it as well.
That's about my thousand words gone so we will finish with some comment from JB as to what's wrong with the fund management industry. He reckons that there has been a shift in focus from asset management to asset gathering and this shift encourages index hugging which produces basically the performance of an index fund with much higher costs.
JB also decries the tendency of the fund management company to present a wide variety of funds to investors and encourage them to switch funds as trends change. The problem with this strategy is that it costs lots and investors tend to chase winners just as the winner starts to lose.
Bogle has his own website and interested readers should check him out at : johncbogle.com
Incidentally reading this article in the Chartered Financial Analysts Journal qualifies for continuing education credits if you are a Chartered Financial Analyst. In NZ reading this article counts for nothing if you are an Authorised Financial Adviser (AFA). The irony of this is made all the more painful by the fact that achieving a CFA qualification is about a million times more difficult than becoming an AFA.
Disclosure: Brent Sheather has been investing with Vanguard since about 1990. Vanguard pays no commissions or trailing fees.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.
