Sometimes when you want to find out how someone you admire ticks, you ask them whom they respect. When it comes to super-investor Warren Buffett, the answer (among others) is Jack Bogle, the founder of the Vanguard Group.
Jack Bogle should be awarded the Nobel Prize in Economics for bringing the passive index fund into the world. This vehicle simply holds a basket of securities at very low cost.
It should be a staple in your portfolio. It's saved investors hundreds of millions of dollars over the past four decades.
In Buffett's most recent Berkshire-Hathaway annual shareholder letter, Buffett goes out of his way to praise Bogle, who is still defending individual investors from the ravages of Wall Street.
"If a statue is ever erected to honor the person who has done the most for American investors," Buffett wrote, "the hands-down choice should be Jack Bogle.
For decades, Jack has urged investors to invest in ultra-low-cost index funds.
In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value."
Buffett's -- and Bogle's -- premise for Main Street investors is simple: You almost never beat the market with active management because managers' fees eat into your performance.
It is rare that you'll beat a cheap, passive index fund because cost matters.
Disclosure: Jack Bogle kindly wrote a forward for one of my books. I've interviewed him often over the years.
What about those handful of managers (like Buffett) who manage to post great returns? Aren't they the exception to the rule?
Yes, but how do you identify them ahead of time and know how they'll perform going forward? That is, how do you find (and stick with) the next Buffett?
"There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified," Buffett wrote.
"The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail."
So picking the next great fund manager is a needle-in-a-haystack problem. Almost none of us can predict the future, and if we stumble upon a winner, it's mostly by luck.
Then there's the seeming curse of success. If a manager has a good year, he will attract more investors along with even more pressure to have more good years.
And it's unlikely that he'll be able to beat the market after fees are deducted. Those who succeed are probably getting the roll of the dice, Buffett surmises:
"Some investment professionals, just as some amateurs, will be lucky over short periods. If 1,000 managers make a market prediction at the beginning of a year, it’s very likely that the calls of at least one will be correct for nine consecutive years.
Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."
Can a successful manager ever do well over time? Buffett doesn't think so. "There are three connected realities that cause investing success to breed failure.
First, a good record quickly attracts a torrent of money. Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions (sob!)."
“The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees," Buffett concludes, "it will usually be the managers who reap outsized profits, not the clients,” Buffett wrote.
“Both large and small investors should stick with low-cost index funds.”
What should you do? Listen to Buffett, but invest like Bogle.