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Stepan Lavrouk
Stepan Lavrouk
Articles (343) 

Jack Bogle: The Stock Market Is a Giant Distraction

Investing consists of 2 different games

November 18, 2019

“Price is what you pay, value is what you get,” as Warren Buffett (Trades, Portfolio) is fond of saying. This is a sentiment that has been echoed by many a value investor over the years. Although it flies in the face of academic doctrines like efficient market theory, the basic premise that prices often diverge wildly from reality is believed by all sorts of professional investors.

The late Jack Bogle, the father of passive investing, was no different. In his book, "The Little Book of Common Sense Investing," he addressed this idea by saying that investing consists of two different games - the real market and the expectations market.

The short run versus the long run

Bogle was a great believer that in the long run, an individual who invested in American business would reap great rewards if they consistently reinvested their earnings and took advantage of the power of compound interest. This investor’s results will be much higher if they minimize the proportion of their earnings that get eaten up by management and trading fees. I recently wrote about the basic logic of Bogle’s thinking, which you can read here.

In "Common Sense," Bogle said that although he had no idea how to forecast short-term price fluctuations (and that no one can do this), he was confident in saying that in the long term, investing will pay off. Why?

“Simply, it is investment returns - the earnings and dividends generated by American business - that are almost entirely responsible for the returns delivered in our stock market. Put another way, while illusion (the momentary prices we pay for stocks) often loses touch with reality (the intrinsic values of our corporations), in the long run it is reality that rules.”

The two games

The first game is the "real market" - the realm of actual business transactions. Here, companies produce things that actual consumers buy, and spend real money to pay off real debt and return real cash to real shareholders. The second game is the "expectations market" - the stock exchange, where participants trade shares back and forth based on what they think the real market will do in the future.

“The expectations market is not only a product of the expectations of active investors but the expectations of active speculators, trying to guess what these investors will expect, and how they will act as each new bit of information finds its way into the marketplace. The expectations market is about speculation. The real market is about investing. The only logical conclusion: the stock market is a giant distraction that causes investors to focus on transitory and volatile investment expectations rather than on what is really important - the gradual accumulation of the returns earned by corporate business.”

If this sounds like something Buffett or Benjamin Graham would say, that’s because it is. Although passive investing as advocated for by Bogle is sometimes portrayed as being oppositional to the active investing practiced by Buffett and other value investors, it is very much of the same mind. The only real difference is that Bogle goes one step further - not only can investors not predict short-term price fluctuations, but they are incapable of forecasting the prospects of individual companies.

This last point is somewhat more debatable than the first - although the data shows the average active investor does significantly underperform the market. Regardless of where you come down on this issue, the fact that both Buffett and Bogle agree that profitable short-term speculation is essentially impossible is information that should be taken seriously by all aspiring investors.

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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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