In an interview, John Bogle was once asked about the perfect portfolio. His reply was that there were no easy answers. As he explained, “I got a letter from clearly a young man who was really worried about how he should be investing and what his allocation should be. He said, you know it’s a dangerous, risky world out there. (...) Of course, he’s right. (...) I said to him, you don’t know, and I don’t know what’s going to happen to any of them. The market doesn’t know. Nobody knows, so you just have to put them out of your mind and forget it. What you want to think about is how much risk you can afford, and that’s very much a personal thing.”
Bogle, the founder of Vanguard Group (VOO, Financial), was one of the pioneers of index investing and a staunch advocate for the average investor. Over his long career, he shared his investing philosophy, emphasizing simplicity, discipline and a long-term perspective. For Bogle, the perfect portfolio is tailored to an investor’s specific risk tolerance and goals. While there is no one-size-fits-all approach, Bogle offered guidance on key principles for portfolio construction.
Building a solid foundation: The boring money account
The core of Bogle’s recommended portfolio is having a “boring money account” invested primarily in index funds. Bogle suggested putting at least 95% of investable assets into low-cost, diversified index funds. This includes stock index funds, which invest in the broad stock market, and bond index funds, which invest in bonds.
Bogle recommended allocating between stocks and bonds based on an investor’s age and risk tolerance. Younger investors may favor a higher stock allocation, while older investors closer to retirement may shift more assets to bonds. Bogle suggested a reasonable starting point is allocating 60% to stocks and 40% to bonds. Rebalancing occasionally may be warranted to maintain the target asset allocation.
The power of long-term investing
The key is investing in this boring money account for decades without overthinking or tinkering. As Bogle colorfully put it, “Don’t look at it for 50 years. Don’t peek, but when you retire, open the envelope and be sure to have doctors nearby to revive you because you will not think there is so much money in the world.”
Even modest investments can grow substantial wealth by harnessing the power of compounding returns over a long period. Index funds provide broad diversification and low management fees - precisely what the average investor needs. While it requires discipline, tuning out short-term noise and letting index funds quietly compound over time can reap tremendous rewards.
Embracing speculation: The funny money account
While most assets belong in boring index funds, Bogle understood many investors have a speculative instinct. He acknowledged there is a place for “funny money” investments, which he defined as higher-risk bets like individual stocks.
Bogle suggested allocating a small portion, around 5%, of a portfolio to funny money. This provides an outlet to scratch the speculation itch without jeopardizing the core index fund portfolio. However, Bogle cautioned investors to carefully evaluate funny money investments after five years. Unless significantly outperforming, Bogle advised limiting funny money to maintain focus on index funds.
Investing in individual stocks: A word of caution
When investing funny money in individual stocks, it is critical to only risk what you can afford to lose entirely. As Bogle put it, investors should back into “a sum of money that you could see go down to zero without losing sleep.” Speculation often fails to beat index funds over time but can provide education and satisfaction when done prudently.
Starting with index funds: The importance of mastering the basics
Bogle stressed the importance of gaining experience and discipline before engaging in speculation. His advice was to invest exclusively in index funds for the first five years of investing. As Bogle explained, “Just start off with index funds period and for five years don’t do anything else.”
Spending time focused solely on index funds allows investors to get accustomed to market volatility. By resisting the urge to tinker or speculate during this initial period, investors can see firsthand the benefits of the passive buy-and-hold philosophy.
Rebalancing: A strategy for maintaining your portfolio
While Bogle favored a more passive approach, he acknowledged periodic rebalancing could be prudent for some investors. Rebalancing involves selling assets that have become overweight and reallocating to those that are underweight to restore your original target allocation.
This can be useful after major market swings that skew your portfolio’s asset allocation significantly. Rebalancing trades some short-term performance chasing for risk management aligned with your goals. Bogle suggested reasonable rebalancing bands of 20% above or below target allocations before taking action.
Common mistakes to avoid
While a modest funny money account can have a place in a portfolio, Bogle warned of common mistakes that often undermine returns. These include:
- Frequent trading: Trading too often in a futile attempt to time the market or chase trends wastes money and impedes returns. It generates unnecessary fees and taxes while achieving poor results.
- Chasing hot investments: Blindly buying into the latest fads almost always ends badly. Stick to sound, proven investment principles rather than chasing the hottest trends.
- Emotional decisions: Panic selling in downturns or greedily overextending in rallies destroys wealth. Stay disciplined and avoid making choices based on fear or exuberance.
- High fees: Excessive management fees, commissions and other expenses are reliable portfolio drag. Minimize costs to maximize what stays in your pocket.
While tempting, these mistakes can seriously inhibit portfolio growth. Avoid them at all costs.
Adhering to Bogle’s timeless principles for success
Bogle built his investing philosophy around the virtues of simplicity, discipline and low costs. For most investors, he believed a passively managed portfolio of index funds compounding over decades is the surest path to financial success.
While allowing for a minor allocation to “funny money,” Bogle’s core advice was to start with index funds and resist speculation in the early years. Patience and perspective are required to harness the power of long-term compounding.
By following Bogle’s advice to limit funny money bets, minimize expenses, rebalance judiciously and let index funds compound over decades, you put yourself in the best position to build long-term wealth. Stay focused on the elements within your control, and your portfolio will be well on its way to flourishing.