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What Jack Bogle Left Behind

On Wednesday, we lost John “Jack” Bogle, the founder of the Vanguard mutual fund empire and the inventor of the modern index fund. He was 89.

I doubt if there is a stock market in heaven. Something that evil and capable of producing human suffering really belongs in hell. But if there is a stock exchange in the next life, then Mr. Bogle should be its chairman. He did more than probably any single person in history to improve the odds for regular investors like you and me.

I’d argue that if there were a Mount Rushmore of finance, Mr. Bogle’s head should be on it. He was that influential. Before Bogle’s revolution, high management fees, shamefully high sales loads, and extreme tax inefficiency were the norm.

Today, the fees on many index funds are effectively zero. These are vehicles designed to be bought by cost-conscious investors rather than sold by predatory brokers looking to pocket a commission. You can largely thank Bogle for that.

You’ve probably already read plenty of eulogies to Bogle, so I’ll spare you another lengthy one here. Instead, let’s focus on some of the lessons learned from his long career.

No.1: Fees Matter

This is a big one.

Every dollar you spend in fees is a dollar that’s not available to grow and compound. And over an investing lifetime, it makes a big difference.

Let’s play with the math. Let’s say you invest $1,000 in two funds running identical strategies. The only difference is that one charges a fee that is 1% higher than the other. So, after fees, one returns 9% per year and the other returns 10%.

After 20 years, the fund with the after-fee return of 9% per year would grow to $5,604. Not too shabby. But the fund with the after-fee return of 10% would be worth $6,727, more than 20% higher.

This doesn’t mean that fee minimization is the only thing that matters, of course. If you’re getting a unique strategy or tailored advice, a “high” fee might be worth every penny. But to the extent you can eliminate fees, you obviously should because the savings compound over time.

No.2: Buying and Holding (Usually) Makes Sense

Bogle was proud of his invention, the index mutual fund, which he unveiled in 1975. But he was always a little skeptical of ETFs, even though his firm would eventually become a major player in that space.

While ETFs share the low-cost structure of index mutual funds and some of the same tax benefits, they tend to be used very differently. Unlike mutual funds, which can only be traded once per day, ETFs trade instantly throughout the day. This encourages excessive trading and a casino mentality. And that can lead to lousy returns and unnecessary capital gains taxes to pay.

Index investing worked because it was a long-term strategy. When you buy an index fund, you give up on trying to beat the market. You are the market. And over most long-term time horizons, being the market is just fine.

This doesn’t mean that Bogle was a proverbial Dr. Pangloss who always believed everything was hunky-dory and that stocks always shot up to the moon. In recent years, Bogle publicly stated many times that he expected stock returns to be in the ballpark of 4% per year at best over the next decade.

I’m less ideological than Bogle. I agree with him that indexing is a good strategy most of the time. But I’m not willing to completely throw active strategies out the window. At a time when stocks are priced to deliver lousy returns and the Fed is sucking liquidity out of the system, having more of your assets in active strategies (or, in my neck of the woods, high-yield income investments) makes sense. Passive indexing makes more sense when stocks are cheap priced to deliver high returns over the following years.

We’ll get there again. But we’re not there today.

No.3: Be Independent and Stick to Your Guns

When Bogle first proposed his idea for an index fund, most of his colleagues thought he had lost his mind. To them, a manager had to be paid to do something. Passively following an index seemed absurd.

Of course, as history would prove, Bogle was a visionary. He understood that the stock market had become increasingly hard for large for large-cap managers to beat. They couldn’t beat the market because, due to their size and clout, they had effectively become the market.

It should have been obvious, and Bogle wasn’t the only or even the first to notice it. But he was the first to do something about it, launching an index fund and taking on the entire Wall Street establishment in the process. And as a result, we all invest and trade in the new world he helped to create.

Rest in peace, Mr. Bogle. And on behalf of all investors, thank you.

This article first appeared on the Rich Investor.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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401k Not Enough For You? Add This.

Before I get started, it’s time for my customary beginning-of-the-year nag.

By the time you read this, you will have likely received your first paycheck of 2019. Take a minute to see how much of it you’ve diverted into your 401k plan. Are you on track to contribute the $19,000 for the year? (Or $25,000 if you’re 50 or older?)

If not, take a minute today to log in and increase your contribution levels. The longer you wait, the harder it will be to catch up. So, get it done now, before your next paycheck.

It’s OK if you’re worried about the stock market taking another spill. No one says you have to allocate your 401k to stocks. A money market or stable value fund is a perfectly fine option for now.

It’s simply to get your cash into the account to take advantage of the tax break and any employer matching. The actual investing can happen later.

All right, I got my annual January nag out of my system.

Now, let’s move on to the good stuff.

While the 401k is the backbone of most Americans’ financial plan, if you’re self-employed or a partner in a small business, you have even better options at your disposal. In addition to defined-contribution 401k plan, you can also build yourself a good, old-fashioned defined-benefit pension plan.

I know what your thinking. Words like “defined benefit” or “defined contribution” are enough to make your eyes glaze over. They might even be enough for you to consider the virtues of jabbing an icepick into your temples.

It’s boring. I know.

But hear me out, because if you play your cards right, you can potentially shield hundreds of thousands or dollars from the tax man… every year.

Paying Yourself First

Very few companies offer traditional pension plans today. They’re expensive to administer, they can be a legal minefield, and at the end of the day, no one wants the responsibility of caring for retired workers decades after they’ve quit working.

This is why most companies moved to defined-contribution plans like 401ks. There’s no real risk. Managing the portfolio is the responsibility of the worker, not the company. And if the nest egg doesn’t grow large enough to support the retiree in their golden years… well, that’s their problem.

Hey, I get it. If I were running a large enterprise, I wouldn’t want the open-ended liability of managing a traditional pension for my workers.

But my own retirement? That’s a different story. I don’t mind dealing with the hassle if I’m the one that gets the benefit.

So, with that as an introduction, let me introduce the cash-balance plan.

A cash-balance plan is a traditional defined-benefit pension plan designed for one-man shops or small businesses with a handful of partners. The formula for contribution limits is complex and depends on your age, income and the current value of your plan, among other things. So, it’s probably easiest to explain with examples.

If you’re 40 years old and make $250,000 per year in self-employment income, you can contribute around $106,000 to a cash-balance plan, saving tens of thousands of dollars in taxes. If you’re 50 years old and making $250,000 per year, the amount you can potentially contribute jumps up to over $180,000. And if you’re 55, the number gets close to $220,000.

Sheltering $220,000 per year from the tax man sounds a lot better than sheltering $19,000 to $25,000.

But here’s where it really gets fun. It doesn’t have to be an either/or decision. You can actually do both!

So, playing with examples again, let’s say you’re 50 years old and earn over $250,000. You can dump the first $25,000 into your 401k plan, pay yourself an extra 6% in matching or profit sharing, which would work out to another $15,000, and then top it off with a massive $180,000 contribution to your cash-balance plan.

That’s such a phenomenally good tax break, I can hardly believe it’s legal!

There are a few catches, of course. You need a professional to set up the plan and do the annual actuarial calculations, which will cost you several hundred or even a couple thousand dollars per year. You do not want to get cheap here and try to do it yourself, as making any mistakes can subject you to penalties and a potential tax nightmare.

You also have to invest the cash-balance plan conservatively. Just as is the case with an old-school traditional pension, any portfolio losses have to be made up with higher future contributions. It doesn’t matter if you’re the only participant in the plan and you’re effectively “paying yourself.” You face the same risk that General Motors or Ford do when their pension assets fall short of liabilities.

So, you’d want to make sure your cash-balance plan was invested primarily in bonds, CDs or other low-risk investments.

Once you’ve retired or reached the lifetime maximum contribution of around $2.6 million, you don’t have to worry about dealing with the administration of the cash-balance plan anymore. You can simply roll the balance into an IRA and manage it the same way you would with any other retirement account.

Regardless, if you’re looking to turbocharge your retirement savings, you should definitely look into cash-balance plans. There’s simply nothing else out there that can offer the same tax-deferred growth.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Today on Straight Talk Money…

I joined Chase Robertson and Peggy Tuck this morning on Straight Talk Money:

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Don’t Expect Mean Reversion to Boost Your Returns

My poor groin…

As I wrote a few months ago, I managed to pull my right groin muscle playing soccer with some of the hypercompetitive South American fathers from my son’s team.

Well, with a little rest, it healed. Or so I thought.

But while skiing with the family in Breckinridge, I took a turn too fast, wiped out… and felt my poor groin pop.

I’m able to walk… with a limp. But I won’t be doing anything remotely athletic for at least a few weeks.

Maybe it’s my physical discomfort… or maybe it’s the fact that I’m sitting alone at the lodge while my wife and kids enjoy a nice day on the slopes… but something I read in this week’s Barron’s really put me in a foul mood.

Vito Racanelli writes,

There’s one number that explains a lot of things: 5.52%. Over the 20 years ended 2018, that’s been the nominal compound annual growth rate (CAGR) of the S&P 500.

It might not feel like it after a decade-long bull market, “but we are coming off 20 of the worst years for compounded returns since the Great Depression,” says Nicholas Colas, co-founder of DataTrek Research. The average trailing 20-year market CAGR since 1928 is 10.7%. Blame the two negative-35%-plus bear markets since 2000.

Ouch.

Over the past 20 years, the market has returned barely half its long-term average annual gains. And I’m willing to bet that most investors saw returns even lower than that. (Most investors tend to sell near bottoms and miss out on the most explosive early years of a bull market.)

But this is where I start to get grouchy. Colas goes on to suggest that, since we’re coming off a lousy 20-year stretch in the market, the next 20 years should be a lot better due to mean reversion.

In other words, in order for the market’s long-term returns of 10.7% to hold, we have to see annual returns well above 10.7% in order to make up for the past 20 years of just 5.52% returns.

This may be the stupidest argument I’ve ever heard. And trust me, I’ve heard some ludicrous arguments over the years.

Let’s start with valuations.

A big reason for the market’s lackluster performance over the past 20 years is that we started the period in 1998… smack dab in the middle of the largest stock bubble in U.S. history.  At the beginning of 1998, the S&P 500 traded at a P/E ratio of 24, well above the long-term average.

The returns you earn are a product of the price you pay. If you overpay, your returns are going to be lousy. Anyone buying in 1998 paid too much for their stocks and then had to accept lower returns over the next 20 years. It’s really that simple.

Now, let’s compare this to the preceding 20-year period, 1978 to 1998. Over that period, the S&P 500 returned about 14% per year, well above the long-term market average.

Why?

Again, it’s simple. In 1978, after a decade of stagflation, the market was cheap.  The S&P 500 traded at a P/E ratio of just 8. Anyone buying in 1978 was buying at a bargain-basement price and thus enjoyed a fantastic 20 years of returns.

So, where are we today?

Unfortunately, it’s looking a lot more like 1998 than 1978. The S&P 500 trades for about 20 times earnings.

Now, we can split hairs as to whether the P/E ratio is the best metric to use here. But other metrics, such as the cyclically-adjusted price/earnings ratio (“CAPE”) or the price/sales ratio tell a very similar story. Stocks are not cheap today. And thus it’s not realistic to expect returns over the next 20 years to be much better than over the last 20.

I could end my rant here, but I’m just warming up.

This is bordering on market heresy, but I also take issue with the notion that stocks “have” to return around 10.7% per year.

In 1928, the stock market was still the wild, wild west. It wasn’t really regulated, and it was essentially a casino for rich people. There were no 401ks, and the average American had no access or exposure to stocks. The market didn’t really become accessible to the average American until the 1950s, when mutual funds became popular. And even then, few Americans were investors. I’d argue that investing didn’t really go mainstream until the late 1980s.

Furthermore, up until arguably the 1940s, the United States was still an “emerging market.”

Compare that to today. Virtually every middle-class American has at least indirect exposure to the stock market via their company 401k plan or pension, and the capital markets are tightly regulated by an alphabet soup of government agencies.

All else equal, a highly-regulated and developed market should produce returns that are lower than those of a loosely regulated emerging market. The returns have to be higher in a wild emerging market in order to justify the risk.

I’d argue that the 5.52% returns of the past 20 years are the better example of what we should expect going forward than the 10% of decades past. This is the “new normal” for a developed market with broad participation trading at premium prices. And in order to get that 5.52% annual return, you’re going to have to stomach a lot of volatility.

I don’t know about you, but that sounds like a lousy deal to me.

I don’t want to buy, hold, and pray for 5.52% annual returns. The good news is that I don’t have to. In my Peak Income newsletter, I look for attractive income opportunities that are off the beaten path. It’s not at all uncommon for me to find stocks or closed-end funds paying 8% or more in dividends alone, not including any capital gains.


Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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What to Do Now If You’re Losing Sleep Over the Stock Market

The following is an excerpt from What to Do Now If You’re Losing Sleep Over the Stock Market, originally published by Kiplinger’s.

As discussed ad nauseam in the financial press and in mutual fund literature, stocks “always” rise over the long-term.

This may very well continue to be true. But you also should remember that you have limited amounts of capital, and your cash might be better invested elsewhere.

Stocks are not the only game in town.

Even after the recent selloff, the S&P 500 still trades at a cyclically adjusted price-to-earnings ratio (“CAPE,” which measures the average of 10 years’ worth of earnings) of 27, meaning that this is still one of the most expensive markets in history. (Other metrics, such as the price-to-sales ratio, tell a similar story.)

This doesn’t mean that we “have” to have a major bear market, and stock returns may be soundly positive in the coming years. But it’s not realistic to expect the returns over the next five to 10 years to be anywhere near as high as the returns of the previous five to 10 years, if we’re starting from today’s valuations. History suggests they’ll be flattish at best.

It’s not hard to find five-year CDs these days that pay 3.5% or better. That’s not a home run by any stretch, but it is well above the rate of inflation and it’s FDIC-insured against loss.

High-quality corporate and municipal bonds also sport healthy yields these days.

And beyond traditional stocks, bonds and CDs, you should consider diversifying your portfolio with alternative investments or strategies. Options strategies or commodities futures strategies might make sense for you. Or if you want to get really fancy, perhaps factored accounts receivable, life settlements or other alternative fixed-income strategies have a place in your portfolio. The possibilities are limitless.

Obviously, alternatives have risks of their own, and in fact might be riskier than mainstream investments like stocks or mutual funds. So you should always be prudent and never invest too much of your net worth into any single alternative strategy.

Just keep in mind that “investing” doesn’t have to mean “stocks.” And if you see solid opportunities outside of the market, don’t be afraid to pursue them.

To read the rest, please see What to Do Now If You’re Losing Sleep Over the Stock Market

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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