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Stepan Lavrouk
Stepan Lavrouk
Articles (550) 

Jack Bogle: Don’t Attribute Certitude to History

Past performance is no guarantee of future returns

May 29, 2020

Jack Bogle is considered to be the founding father of index investing. He established the Vanguard Group in 1975, and I dont think it's an exaggeration to say that he revolutionised the way that people invest. Many of the seismic changes that have occurred in the financial world over the last few decades - the collapse in brokerage fees and the rise of passive investing, to name just two - can be traced back to Bogle in the mid-70s.

In 2002, Bogle delivered a keynote address entitled "Dont Count on It! Perils of Numeracy" at his alma mater Princeton University, in which he talked about the common practice of extrapolating out past performance to future returns in the stock market, and why it is so dangerous to rely on this practice.

Learn from history, but dont assume it will continue indefinitely

The idea that common stocks are an good form of long-term investment can be traced back to Edgar Lawrence Smiths 1924 book "Common Stocks as Long-Term Investments." If that name and title sound familiar to you, it is probably because Warren Buffett (Trades, Portfolio) mentioned them in his latest letter to shareholders of Berkshire Hathaway (BRK.A)(BRK.B). In the book, Smith came to the surprising (for him) conclusion that stocks had historically outperformed bonds, which were the more respectable and accepted type of investment security at the time. This conclusion came at the opening of the great 1920s bull market.

Bogle said that just because something was true in the past does not mean that it will continue to be true indefinitely. Past performance is no guarantee of future returns. This is certainly the case in the investing space, particularly when a certain type of security becomes popular and therefore more expensive. We have seen this phenomenon before when we looked at the history of junk bonds in the 1980s. Historically, they had indeed been underpriced, but this changed rapidly as investors developed a voracious appetite for these securities.

In any case, its not difficult to see that no asset class can consistently deliver high returns. There will be down years as well as up years, and thats ok. However,Bogle was more fascinated with the phenomenon wherein professional and highly-paid executives, money managers and consultants will revise their expectations for market returns upwards based on recent history:

A typical corporate annual report expressly states our asset return assumption is derived from a detailed study conducted by our actuaries and our asset management group, and is based on long-term historical returns. Astonishingly, but naturally, this policy leads corporations to raise their future expectations with each increase in past returns. At the outset of the bull market in the early 1980s, for example, major corporations assumed a future return on pension assets of 7%.

By the end of 2000, just before the great bear market took hold, most firms had sharply raised their assumptions, some to 10% or even more. Since pension portfolios are balanced between equities and bonds, they had implicitly raised the expected annual return on the stocks in the portfolio to as much as 15%. Dont count on it!

The temptation to assume that the good times will continue to get even better seems to be irresistible even to sophisticated players like pension managers and corporate executives. Bogles advice, "dont count on it," was a warning to investors who were apt to fall victim to the same temptation, and it still rings true today.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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