More from John Bogle
Bank stocks have taken a huge hit. Do you expect them to continue to underperform, or is this a buying opportunity? - STEVEN HARVEY, TOWACO, NJ
I'm not any good at picking market sectors, but they have been struck pretty darn hard. I would advise that if you own a portfolio that includes bank stocks, you wouldn't want your manager to get out of them now. We just don't know. When you are timing a sector, you have to be right twice -- when you get in and when you get out. That's very difficult to do.
What mistakes did the big banks make in the subprime mess that you think were preventable? - LISA DONNELLY, RYE, NY
Well, it's pretty easy. We started Vanguard in 1974, and in 1981 we started to run fixed income internally. When I was head of this place, I never missed a fixed income group staff meeting. I would always be there, because everything depends on not blowing it! In the equity area, you take a lot of risk. The fixed income area is a stupid place to take risk. So, when someone came in and said, we can earn an extra half percent on this bond, I would say, do you think it has any higher risk? If not, why are they offering us an extra half percent?
So, people thought they were getting something for nothing, when the long-term data on bonds shows that those risk premiums are pretty accurate. So why take your risk in that area? The banks wanted to earn that extra money, and so they got too far out on that limb of risk, and when it snapped off, they should not have been surprised.
Also, I have always been skeptical about the rating services. I think there was tremendous reliance on rating services. It is irresponsible for a giant financial institution to let someone else tell them the quality of the investments in their portfolio. Asking the rating agencies, who get paid to rate each of these CDOs, was like asking the barber if you need a haircut!
Given the current state of Social Security, if you were 30 years old today, would you be putting away as much money as possible for retirement and not rely on SS being there? - VIRGIL HOGAN, ATLANTA
That's a significant overstatement. Social Security is very troubled, but even if we do nothing, I have seen data that says future payments will be roughly 70 percent to 75 percent of what they are now. That's a long way from zero. But the system ought to be fixed, and it's not a complicated system. There's a gap between expenses and revenues, and we have to raise revenues or reduce expenses. We can raise revenues by increasing the wage base, and we can reduce expenses as the cost of living adjustment is overly generous. You could tie it to earnings patterns rather than spending patterns. And if we ever get the system fixed, once we do that, we could allow people, if they want the risk, to privatize their account.
What career advice would you give college grads today? - LAUREEN NELSON, HONOLULU
I spoke to Columbia University recently, and I was trying to acquaint them with what I call the relentless rules of humble arithmetic. The financial services business is like law and government -- it takes money out of society, and reallocates it, but is a drag on society. My rule for any young person is to add value, not subtract it. These institutions are subtracting value. We don't need nearly as many people going into them. There are 83,000 chartered financial analysts. And there are 140,000 people queued up to become CFAs. That's unbelievable. They cannot all make a living and still have anything for the investor. I don't think we need any more creators of complex derivatives. Returns, as Warren Buffett would say, decrease as motion increases.
What defensive positions would you recommend for Baby Boomers approaching retirement? - DAVE FISHER, WYANDOTTE, MI
Well, my own view is that you should think about your bond position as equal to something like your age, less 10 years. So this would mean if you are 70 years old, you need 60 percent in bonds. That may be a bit aggressive, but when you start investing, you have all kids of time and a tiny amount of capital at work. You don't need any income from your investment. The market will not bother you. When you get old, you don't have a lot of time to recover from mistakes, you have a lot of wealth at stake, and you start to need income from your investments, and your emotions may get a bit shaky in times like these. So everything suggests more bonds than stock as age increases. My own position is 60 percent bonds and 40 percent stock, which implicitly means I'm lying about my age. [He's 78.]
In your perception, what is the biggest mistake that the average investor makes when investing for retirement? - PEDRO E. LEZAMA, MARACAIBO, VENEZUELA
I think the biggest mistake is acting much more like a speculator than an investor. Investing to me has to do with putting your capital at work in American business and world business and letting business make it grow. If you just own business, through an index fund, you will capture your fair share of stock market returns. Investors are turning over their mutual funds at a pretty rapid pace - around 25 percent a year - which means they only hold funds for four years. Mutual fund managers are also making the same mistakes, only worse. When I came into this business, in 1951, and for 25 years after, the portfolio turnover was about 16 percent year after year. Now it's running about 100 percent. That means they are holding a stock for one year, maybe less. That's the folly of short-term speculation, and speculators lose.
Many hedge funds seem to routinely beat the market. Is there any way that an individual investor can get similar returns to hedge funds from a modest investment?- MATT YATES, ROCHESTER NY
I don't buy that. I don't see the magic of hedge funds. Some beat the market, but many hedge funds lose to the market, and many hedge funds go out of business too. The average hedge fund return looked just about the same as the return of the Vanguard Wellington Fund, a conservative balanced fund, over the previous decade of hedge fund hegemony. I think the hedge fund miracle is people looking at Yale and Harvard and Princeton and saying they've done very well with alternative investments, but you cannot generalize that to the market. It would be foolish for nearly every individual investor, especially those with modest means, to try to invest in a hedge fund.
Are international index funds a relatively safe bet to hedge against the declining dollar? - BOB SEFCIK, KENNETT SQUARE, PA
That is the intelligent way to invest internationally. It is better to index internationally for one simple reason: the cost of international mutual funds are higher, so the savings for international index funds are greater, so your share of the market return will be proportionally enhanced. You are also less likely to trade them back and forth.
Hedging the dollar is highly complex because that presumes the dollar will continue to decline. I don't know that. My expectation, and we might be close to it, is that the dollar has done all the erosion it's going to do. The dollar is a shadow of what it used to be, but that will not go on forever. I'm not sure that a US investor, getting paid in dollars, buying gas in dollars, has a particular need to hedge against the U.S. dollar.