Disclosure: This does not constitute investment advice. I am not a financial professional. To paraphrase Penn Jillette, anyone who takes investment advice from me is a moron and deserves to go broke. If you want a better understanding of the concepts in the piece, I recommend John C Bogel’s The Little Book of Common Sense Investing. It is arguably the only investing guide you need ever read and it is an easy read to boot. There is also a group dedicated to advancing Jack Bogle’s ideas - they call themselves Bogleheads. The website looks like something from 1995!
King Solomon, reputed for his wisdom, is said to have had a ring which could make a sad person laugh and a happy person weep. Inside was inscribed the phrase, “This too shall pass.”
I often imagine that I have a similar ring with which to reflect on the state of my retirement savings: it cheers me when things look bleak and chastens me in times of irrational exuberance. The inscription inside my imaginary ring reads, “reversion to the mean.”
John C. Bogle (1929-2019), the “father” of index investing and long-time chief at the investment firm Vanguard, advocated for a passive form of investing. In his view one should simply buy shares in a mutual fund, a basket of stocks, that replicates an index like the Standard & Poor 500, an index of the largest U.S. publicly held companies, and perhaps a second fund that holds intermediate term U.S. bonds. By doing so one would more or less replicate the return of the U.S. stock and bond markets as a whole. No better, but no worse either, as long as you don’t try to buy or sell the fund at the “right” time to juice your returns. Just buy and hold and don’t look at it for forty years or so. Your returns will be just average and average will be just fine.
Bogle also said that one of the biggest drags on returns are the fees charged by the company that is managing the funds. Therefore it is important to pay no fees to a fund manager (If you are paying a percent of your investments under management to a fund manager stop immediately!) and just a very small amount to the company managing the fund. Index funds are available today for an annual fee of around two basis points or .02 of one percent. Some firms like Fidelity offer some index funds with no fees at all as a way to attract your business. (They hope to be able to sell you something else once you are a client.)
By consistently investing in an index fund, never selling because of a downturn, and making sure your fees are low, given enough time, you can accumulate enough to not have to work the last couple of years of your life. Maybe the last 20 if you are lucky and/or frugal enough.
One of the hardest parts of his formula is the “never selling in a downturn” part. For someone like me (early in retirement, no significant income to speak of, and potentially many years ahead) a year such as this, when the S&P 500 (and thus roughly 80 percent of my savings) is down about 20 percent as of this writing, can be scary. The other 20 percent of my savings is in a bond fund which although theoretically more stable is still down around 12 percent this year because bond prices fall as interest rates rise, which they have been doing with vigor this year thanks to the Federal Reserve’s war on inflation.
As Bogle pointed out, the market will swing, sometimes very widely. It will go high and it will go low.
But how do you even know whether the market is high or low, that is to say overvalued or undervalued?
One common measure is called the P/E ratio. It is a simple concept. You take the price of all the stocks in the index and divide by the earnings of all the stocks in the index. That generates a number that can vary from five to 70, which represents how much it costs to get a particular return. The historical average or “mean” is about 16. As of this writing the P/E for the S&P 500 is about 20. This would suggest that the market is still overvalued and that it may (though it may not) fall further. In any event, the ratio will one way or another eventually return to or close to its historic mean. There may be times when it will dip below the mean before rising back to the mean again.
I have lived through bigger drops in the market, most recently in 2008 when the S&P 500 dropped 38 percent. The difference was that I was still working and that drop made no practical difference in my life. I underestimated the difference in the emotional impact of a drop in the market when one only has one’s investments to live on.
Here’s how I remind myself to stay the course and avoid temptation to try and time the market.
I remember the reality that a P/E ratio of 37 (as the market was in December 2021) was absurd and that a downturn was inevitable because: reversion to the mean.
I consider that my retirement plan is based only on getting average returns of the market. I don’t need, nor will I get anything more because: reversion to the mean.
I know that the stock market will eventually drop further (in terms of P/E) until the S&P 500 reaches its historic average or even below. When it does drop below, it will eventually go back up again because: reversion to the mean.
In a video clip I saw recently, Warren Buffet (arguably the greatest investor of all time) said that ideally with investing, once you buy a business, a stock, a fund, you should never look at the price again. The only time you care about the price is the day you buy it and the day you sell it. In between, you only look at what the business is producing. I am not that disciplined. I look at the prices more often than I should, but when I do I also remind myself that the prices on a given day are meaningless.
In my case, the business that I own is an infinitesimal slice of all the large businesses in the US. There are some that are doing well in the short term (Apple) and some that aren’t (Facebook, Tesla). On average those businesses are doing, well, average, inflation and recession notwithstanding. The size and strength of the U.S. economy are still among the best, if not the best, in the world.
Ultimately, I can’t predict how anyone of those individual businesses will do. I can be reasonably confident that on the whole, U.S. business will return average U.S. results.
To be average is my highest aspiration.