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John Bogle: Understand Mean Reversion and Think Long Term

The father of index funds had a lot to teach aspiring investors

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Stepan Lavrouk
Dec 10, 2020
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Depending on what metric you use, John Bogle may have been the most influential financial figure of the 20th century. In 1976, Bogle founded Vanguard, an asset management firm that launched the world's first index fund. At the time, the idea of an index fund seemed silly to a lot of people. How could mindlessly following an index yield better returns than actively managing a portfolio? Bogle's insight was to realize that most capital allocators are not as smart as they think they are, and that the fees regular investors paid to mutual fund managers were not commensurate with the returns those funds earned.

Since 1975, Vanguard has grown to become the second-largest asset manager in the world (after Blackrock (

BLK, Financial)), so it's safe to say that Bogle knew what he was doing. But his influence extends beyond the creation of a single firm. Vanguard was able to demonstrate to the world that passive investing can lead to greater returns than active management and since its inception, there has been a huge proliferation of various index funds, exchange-traded funds and other passive strategies. Here are some of the lessons that investors can learn from Bogle.

Understanding mean reversion

Bogle was a great believer in mean reversion - the idea that all things will, over the long term, trend back toward their historical averages. He is most well known for applying this idea to the mutual fund industry. He noted that retail investors tended to pile into the best-performing mutual funds, ignoring the fact that periods of overperformance tend to be followed by periods of underperformance, and vice versa. This concept can also be applied to markets and individual stocks - their prices will, over time, converge to a fair value.

Why is this important for value investors? It is important because markets can go through long periods where prices remain excessively elevated for some stocks or sectors and excessively depressed for others. In these kinds of environments, it's easy to see how so many capital allocators give up on rigorous value strategies and just put their money into whatever asset class is currently performing best.

Always think in the long term

Mean reversion is a powerful strategy, but it can require a significant amount of time for it to kick in. Bogle believed that one of the best things someone can do to compound their wealth is to start investing early. Some simple arithmetic can explain why this is the case.

Let's compare two individuals. Individual A begins investing at age 25 and puts aside $2,000 a year. Individual B begins investing at age 40, but puts aside $4,000 a year. Both of them earn 5% per year. Who do you think will have a larger account by age 70?

Individual A will have put $90,000 towards their retirement, while Individual B will have put $120,000 towards theirs - $30,000 more. However, because Individual A started investing earlier, they will actually end up with a larger amount of money at age 70 - $353,340 versus $296,331. This example illustrates Bogle's thinking very well - starting to save early is one of the simplest ways to ensure a large retirement account.

Disclosure: The author owns no stocks mentioned.

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