Friday, June 28, 2013

Ignore the Noise: John Bogle on Market Fluctuations

John Bogle offered the following during this recent interview with Morningstar's Christine Benz:

"Well, we have to get investors everywhere, and not just retirement plan investors, [onto] the idea that these daily leaps and plummets in the stock market are meaningless. As I've said in more occasions than I care to count, Christine, the stock market is a giant distraction to the business of investing. Because investing is owning corporations that provide goods and services, hopefully more and more efficiently to lower prices, and that's capitalism at work. … They make earnings, they reinvest, pay dividends, reinvest the rest to build the business, that's classic capitalism. That's what I call investment return, dividends and earnings growth..." 

He later added this on the importance of ignoring short-term market price action:

"So, we've got to get people away from looking at the market, and one of my investment rules, as you well know, is don't peak. Don't look at your retirement plan accumulations. If you don't do it for 50 years, you will be thunderstruck with the amount you have when you open that final statement. You won't even believe it. It will be sensational. By looking, all it does is distract you and get you to take action where none should normally be taken."

Underlying fundamentals don't change nearly as much as the daily fluctuations might seems to indicate: 

"And stocks go up and down every day, not based on a change in the fundamentals, because the fundamentals don't change every day for heaven's sake. 

So, we're our own worst enemies. So we want to get a little better investor behavior..."

At a minimum, learn to ignore near-term market fluctuations. Better yet, allow its tendency to misprice assets to serve.

"Mr. Market is there to serve you, not to guide you." - Warren Buffett in the 1987 Berkshire Hathaway (BRKa) Shareholder Letter

In many fields success depends on lots of action. Investment is quite different from that. There's a bunch of hard work involved but it has nothing to do with trading market action; it has to do with understanding what something is worth now and judging how much it is likely to change -- within a range -- over longer time frames. That's hard enough to do well. It's decisively buying what you understand well and being disciplined about allowing for sufficient margin of safety. It's knowing what you don't know. It's about owning sound assets, bought at fair or better prices, while minimizing frictional costs and mistakes.

For most, the index fund bought (not traded) for the long haul consistently over time is a very convenient way to accomplish this. Whether indexation, the purchase of individual marketable stocks, or some combination makes sense as an investment approach is necessarily unique to each investor. Still, no matter what the circumstances, it makes sense to reduce frictional costs and limit trading activity.

Remember that each portfolio move is not only a chance to enhance returns, it's an opportunity to incur additional frictional costs and make additional mistakes.

Respect the illusion of control.

Some underestimate this a great deal and that can be costly.

Of course, none of this applies to someone with a short time horizon but, otherwise, developing the habit and temperament to at least ignore market fluctuations and, if anything, allow market action to serve is a generally good one.

The more confident one is the quality of what they own and what it is worth, the more they should embrace a drop in price. If something was bought at a discount to intrinsic value in the first place why be bothered if the discount temporarily gets even bigger?*

A good test as to whether one is involved in speculation or investment is in their reaction to a drop in price.

Lots of productive assets -- things like private businesses, farms, real estate -- are fine investments but have no quoted market value. The owners of these businesses don't constantly check to see for how much they could sell their ownership position to someone else. Well, it's best treat common stocks -- or the index fund that is holding common stocks -- in a similar fashion.
(The fact that part ownership of a fine business that's reasonably -- or even better than reasonably -- priced can be established very easily and at low transaction costs should be an advantage. It makes no sense to turn it into a disadvantage by constantly trying to buy and sell. Just consider how much more the transaction costs are for the purchase of productive assets other than stocks.)

So, as long as per share intrinsic value gets judged reasonably well, and especially if a discount to that value was paid, a long-term investor should logically like the idea of a drop in price.**

That's the case even if the drop occurs post initial purchase. At the very least, the long-term investor should be neutral toward price drops.

A speculator, understandably, likely will not feel the same way.

Speculation may provide more excitement, at least in the eyes of some, but the evidence more than suggests -- between the mistakes made and the unnecessary frictional costs -- most won't do well who attempt to play that game.

Investment has as its emphasis what an asset can produce over a very long time frame. Speculation has as its emphasis market price action and how to profit from it. Naturally, there's nothing wrong with speculation but it is much less similar to investment than some seem to think.
(No doubt their are individuals who are capable speculators, of course.)

Finally, no matter what investment vehicle(s) makes sense for an individual (again, that's necessarily unique to each person and the circumstances) it's foolish to not allow the magic of compounding to work.

As John Bogle said in this Frontline report earlier this year:

"What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compounding cost. It's a mathematical fact. There's no getting around it. The fact that we don't look at it, too bad for us." - John Bogle

It also makes no sense to be held back by "the tyranny of compounding cost".

Otherwise, investing well means mostly just getting out of the way while consistently making wise purchases along the way.

Ignore the noise.


* The investor can buy more at a bigger discount as can the company itself via buybacks.
** If business value was misjudged then a price drop is a real problem. The emphasis should be on intrinsic business values not market price action. Business prospects change and sometimes it's for the worse. The price paid relative to value matters, of course, but durable high quality business economics are what matters even if some choose to instead focus on exciting growth prospects. 
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