I owe a great debt to many other authors and teachers who have helped me understand investing. One of my favorites is John Bogle, founder and former chief executive officer of the Vanguard Mutual Fund Group.

I recommend John’s “The Little Book of Common Sense Investing” to anybody interested in successful long-term investing through index funds. I quote this book often because it does a great job of teaching simple lessons that are invaluable to any investor who wants to rise above mediocrity.

Today I offer four lessons from John’s book, with permission from John Wiley & Sons, the publisher of “The Little Book of Common Sense Investing” (and publisher of my own book, “Live It Up without Outliving Your Money!”).

Lesson One: Control what you can. Investing involves many facets, most of which are beyond the control and even the influence of us common investors. But one thing you can control, at least to a great extent, is how much you pay for somebody to manage your money for you. Expenses, in other words. Index funds are much less expensive to buy and to own than actively managed funds.

I believe the majority of investors fail to understand what they are paying and are ignorant of the true cost of this negligence. As John points out, mutual fund management and operating expenses average about 1.5 percent per year of fund assets. If you add an initial 5 percent sales charge spread over a five-year holding period, that’s another 1 percent.

On top of that, there is what John calls “a giant additional cost, all the more pernicious by being invisible. I am referring to the hidden cost of portfolio turnover, estimated at a full 1 percent per year. The average fund turns its portfolio over at a rate of about 100 percent per year, meaning that a $5 billion fund buys $5 billion of stocks each year and sells another $5 billion. At that rate, brokerage commissions, bid-ask spreads and market impact costs add a major layer of additional costs.

“Result: The ‘all-in’ cost of equity fund ownership can come to as much as 3 percent to 3.5 percent per year.”

Lesson Two: Index funds are very different from actively managed funds.

In John’s words: “During the quarter century from 1980 to 2005, the return on the stock market (measured by the Standard & Poor's 500 Index) averaged 12.5 percent per year. The return on the average mutual fund averaged just 10 percent. …

“Simply put, our fund managers, sitting at the top of the investment food chain, have confiscated an excessive share of the financial market’s returns. Fund investors, inevitably at the bottom of the food chain, have been left with too small a share. …

“On first impression that annual gap may not look large. But when compounded over 25 years, it reaches staggering proportions. A $10,000 initial investment in the index fund grew by a remarkable $170,800, compared with growth of just $98,200 in the average equity mutual fund – only 57 percent of the total accumulation in the index fund.”

Lesson Three: Investment returns look very different after those returns have been adjusted for inflation.


“… Both of these accumulations are overstated because they are based on 2005 dollars, which have less than half the spending power they enjoyed in 1980. During this period, inflation eroded the real buying power of these returns at an average rate of 3.3 percent per year. When we turn those nominal dollars – the dollars that we earn and spend and invest every day – into real dollars that are adjusted to take inflation into account, the results for that original $10,000 investment tumble sharply. The cumulative real profit, after compounding, came to just $40,600 for the average actively managed equity fund.”

Lesson Four: Investors rarely get the same returns that funds offer, because they put money in and take it out in counterproductive ways. In other words, investors make faulty buying and selling decisions.  

A mutual fund’s reported return, John says, “does not tell us what return was earned by the average fund investor. And that return turns out to be far lower” because money tends to flow into funds after good performance and back out after bad performance.

“When we compare traditionally calculated fund returns with the returns actually earned by their investors over the past quarter century, it turns out that the average fund investor earned, not the 10 percent reported by the average fund, but 7.3 percent – an annual return fully 2.7 percentage points per year less than that of the fund. … Yes, during the past 25 years, while the stock market index fund was providing an annual return of 12.3 percent and the average equity fund was earning an annual return of 10 percent, the average fund investor was earning only 7.3 percent a year.”

I think these lessons are worth teaching again and again. I’m going to keep doing that at every opportunity.