Investing at the end of the world

Issue #27

Feb 06, 2022

Hello doomed humans, Fool here.

Apocalyptic, War, Danger, Apocalypse, Disaster

I know it's been a while since I wrote something. So, I decided to take revenge on you and torture you by writing a loooong post. The markets look a little weak, and people are freaking out. All the long term investors who started investing since the last week are claiming that Nifty is going to become Nifty 0 because of the Fed, inflation, and global debt. The world is ending, apparently.

Every single investor knows the basics of investing i.e., to not react to the constant stream of apocalyptic noise. Yet, they do and regret it.

So this time, I’m trying something different. I’m not going to tell you what to do instead, I’m borrowing the wisdom from an investing superhero. I have some timeless lessons and wisdom about investing and markets from my role model—Jack Bogle.

What makes Bogle's advice special is that it's ridiculously simple and doesn't take a 180 IQ to understand. You don't feel like using a quant algorithm to choose a knife and use tactical allocation to stab your eyes out if you read his advice. In an industry filled with needless compextalk and gratuitous scented bullshit, Jack Bogle spoke to the common people like you and me. His voice will be sorely missed.

None of what's in the post is a secret. It's absolutely basic and astonishingly simple, and that's what makes it valuable. These things need to be told over and over again because we live in an age of shortsightedness and unbridled speculation.

This post was an education for me as I wrote it. I hope it helps you as we head into what's most likely a turbulent market phase.

This post may break in your inbox, please open it in your browser. Here’s the link.

Have you heard this story before?

You discover the stock market. You start watching and reading CNBC, Moneycontrol and ET. You discover some amazing people with golden hearts generously sharing tips on what to buy and sell.
You are unable to understand why people work day and night when making money is so easy in the stock market.
You start picking stocks, and they start going up. You are physically on Earth but mentally on the moon.
You discover Technical Analysis and buy more stocks by drawing lines on a chart. Stocks keep going up. You feel Kabhi kabhi lagta hai apun hi bhagwan hai.
You start tweeting about how you're outperforming Warren Buffett and why people listen to a random old guy.
Stocks start going down. Your pants become slightly wet but still mostly dry.
Stocks go more down. You think the stock market is rigged and that the Gujjus are manipulating it. Mr Market brutally abuses you—emotional atyachar.
You lose more money. You discover mutual funds and start investing in them. You're unhappy about how slowly you're getting rich. But Mr Market's emotional atyachar is fresh in his mind, so you bite your tongue and SIP.
After some time, you start hearing about active management, fund managers, expense ratios, and beating benchmarks. You try to see what the fuss is all about. You google and look at the performance of your active funds.
Shock laga 😲
Active fund managers are ripping you off. You're angry and do more Google.
You discover something called index funds and an old white guy called Jack Bogle and his book The Little Book of Common Sense Investing.
You achieve enlightenment.

This is is pretty much the investing journey for most of us—it certainly was for me 😅 Rick Ferri has a much more succinct version of the journey:

Rick Ferri @Rick_Ferri

A successful index fund investor goes through four phases: 1) Darkness - takes advice from everyone; 2) Enlightenment - realizes a market return is superior to their return; 3) Complexity - overdoing everything to find optimal; 4) Simplicity - invests in a few total market funds

If you’ve been through something similar early on in your investing journey, then it's a good thing. People get mad when I say this, but the best way to learn about investing is by losing some money. You can read all the books and listen to all the gyan in the world, but nothing teaches you like the pain of losing money.

The earlier this happens, the better because you'll have less money when you’re young. But, it can be pretty costly if you figure out your financial mistakes later on. For example, I know many people who thought the stock market was a scam and kept all their money in FD's. Nothing wrong with it if you can make the situation work for you. If not, things can be quite costly later on in life.

Realizing what you're good at and what you aren't in investing is one part of the journey. Assuming that you were a really good stock picker, this journey would've ended at the apun hi bhagwan hai stage.

But let’s say you made all the mistakes like getting scammed by LIC uncles, picking penny stocks and trading by drawing random lines on a chart. Let’s say you figured out that simple portfolio low cost index funds, smart beta funds, active funds (yes, there are a few good ones if you can find them 😉), and debt funds are the way to go.

Good.

But this is where the tough part starts.

Because now, you’ll have to fight against yourself and your human nature. There’s a monkey inside our brains, and it constantly wants us to pay attention to what it wants.

It wants you to enjoy now vs saving for tomorrow.
It tells you that you’re a genius, and you are a star stock picker, superstar market timer, and blockbuster trader.
It tells you that the market will crash, and it’s time to go to 100% cash.
It’ll convince you that XYZ mutual fund will beat Nifty like a rabid dog.
It’ll convince your Reliance Power is a deep value stock.

Don’t listen to the monkey. It’s lying to you.

Homer Brain GIF - Homer Brain Monkey Brain GIFs

Ok, in true Indian filmi ishtyle, I’m finally getting to the point of writing a post very, very early.

The markets, especially the US, have been wobbling a bit in the past few weeks. The headline indices haven’t fallen much, but several fundamentally strong companies with negative profits and consistent debt…ability have cancelled their plans to go to the moon.

Several long-term investors who started investing since Jan 2022 have called this crash the worst stock market crash since the 2008 crisis. One 16-year-old investing guru even was overheard saying, “this crash is worse than the great depression, when the Dow Jones fell 90%.”

I had written this post in March 2020, when Nifty 50 was just 8700 points from going to 0. In the post, I had chronicled the investing advice of some really smart people. If you read the post, you’ll see that much of the advice came true because of the rip-roaring recovery and rally we’ve had since then.

But listening to the advice and acting on it still would’ve been a mistake. The point I was trying to make back then was, “buying the dip” just because there was a dip was stupidity. Conversely, selling because of a dip was twice as stupid. The best thing to do was to follow an existing plan and not react because Nifty was down or up 20-30%.

But people don’t listen. Millions of books, blogs, and videos on why reacting to market volatility is dumb, and yet people continue to do the same old stupid shit.

Why?

It’s easy to conclude that people are stupid, but that would be a stupid conclusion—sadly, one that’s fairly common. Look, it’s perfectly fine to be scared shitless when the markets fall. It’s in your genes. We were programmed to run when there was a threat, and a market crash feels like a threat. We sell to protect our money.

Jim OShaughnessy had tweeted this brilliant thread a long time ago:

Ok, the markets look like they may fall or they may go up, I don’t know, and neither do you. But assuming that the markets will be volatile this year, what should you do?

If you were to listen to someone about how to invest, would you listen to an idiot with a picture of a monkey (me) or someone who founded an $8.5 trillion asset management company? If your answer is me, thank you for your kindness, but you’re an idiot! You obviously should listen to the $8.5 trillion man.

That $8.5 trillion man is Jack Bogle; sadly, he’s no longer with us. Jack Bogle is the founder of Vanguard, the second-largest asset manager in the world, and the father of the humble index fund.

Why should you listen to old man Bogle?

The financial services industry is notorious for rent-seeking. The very existence of the industry is predicated on overcharging, stealing, and gouging as much as they can while giving back as little as possible. In such a godforsaken industry, Jack Bogle was a rare exception. He was a beacon of honesty and integrity. He’s maybe one of five people I look up to in this godforsaken industry that’s filled with liars and crooks.

Text within this block will maintain its original spacing when published

As an aside, I know I’m being a bit harsh. For all its follies, the financial services industry has given us innovations like the Index fund, ETFs, term insurance, almost free investing, and countless free tools. But they do far more damage compared to the value they create.

I’m too young and too poor to say what will make you rich, but I know what won’t. It’s doing ridiculously dumb shit with your money. I might be young, but I’ve been lucky enough to have a front-row seat to the dumbest shit people do with their money, right from my own family to friends.

So, what do you do?

As I was thinking about how to convince you not to do something stupid if the markets fall and I came across something Jack had written. It was this chapter titled “Ten Simple Rules for Investors and a Warning for Speculators” from Jack’s book The Clash of the Cultures: Investment vs Speculation.

These ten rules are probably the most obvious and commonsensical rules you’ll ever hear, you already know them too, but they are damn hard to follow. But the best part is, you can’t control the market direction, but you can control all these ten things. That’s what makes them so insightful.

Here are ten timeless investing principles from the legendary Jack Bogle.

1. Remember Reversion to the Mean

There aren’t a lot of certainties in investing. The one certainty that Bogle talked about over and over again is reversion to the mean. Simply put, yesterday’s best performing funds are tomorrow's worst-performing funds. But still, retail investors chase the hottest funds.

If they paid attention, they’d realize then even mutual funds tell them not to chase performance. Remember this annoying disclaimer?

“The past performance of the mutual funds is not necessarily indicative of future performance of the schemes.”

But for retail investors, the opposite is true: past performance is always equal to future performance.

It's not just retail investors, even large pension funds, endowments, and institutions with all the data and expertise in the world suck at picking good active fund managers ¹ ². Most pensions and endowments select managers based on the past 3-year track record. If that wasn't stupid enough, they fire them after a few years of underperformance. Research shows that the fired managers go on to outperform after 😂

Retail investors pick yesterday's hot fund, the performance drops, they move on to the next hot fund and repeat. The end result is they barely end up with fixed deposit returns. This is why just about 3-4 investors out of 10 stay invested in equity funds after 3 years.

It might sound like a crazy thing to say and believe today, but Bogle also thought the same about market fundamentals. They may go crazy in the short run, like today probably, but they always return to sanity in the long run:

“Remember RTM” is the first of these 10 rules. The message is that selecting your fund for tomorrow by picking a winner from yesterday is an exercise fraught with peril. No, the past is not prologue. This RTM concept applies not only to fund managers, but to fund objectives. Yesterday’s growth fund leadership is often tomorrow’s value fund leadership. The same is true with large-cap funds and small-cap, and with U.S. stocks and non-U.S. stocks
Like a pendulum, stock prices swing far above their underlying values, only to swing back to fair value and then far below it, and then converge again. When returns in the stock market get way ahead of the fundamentals—or way behind— RTM will strike again, sooner or later

“Through all history, investments have been subject to a sort of Law of Gravity: What goes up must go down, and, oddly enough, what goes down must go up.

The bottom line here is that the best-performing funds become worst and vice versa. But index funds continue to earn market returns. They are neither the best-performing nor the worst-performing—they are squarely in the middle. On a long enough timeline, they are virtually guaranteed to outperform most other active funds. What more do you want?

Here’s something Anish had shared a while ago about how Indian stock market performance in the long run closely tracks earnings. Ben Graham wasn’t lying:

'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' — Benjamin Graham

2. Time Is Your Friend, Impulse Is Your Enemy

The one “strategy” that has the highest odds of working is investing in low cost broad market equity and debt index funds and holding them for a really long time.

Let me tell you something shocking: 3-5 years isn’t long term. I blowed your mind, right? I know, I know, I have too much wisdom 😎

This advice is as simple as it gets, but in my limited experience, only about 2-3 people can pull it off.

Everybody knows this, yet few people do it. It’s because that monkey in our head I was talking about earlier always makes us do the dumbest things like poor market timing, chasing fads, listening to idiots, and underestimating our stupidity.

Long term investing is like eating healthy—deceptively simple in theory but surprisngly hard in practice:

Never forget that time is your friend. Take advantage of it, and enjoy the miracle that is compound interest.
Impulse is your enemy. Realize that one of the greatest sins of investing is to be captivated by the siren song of the market, which can lure you into buying stocks when they are soaring and into selling stocks when they are plunging.
As Shakespeare wrote in a different context, “a tale told by an idiot, full of sound and fury, signifying nothing.” If you allow your impulses to take over your rational expectations, of course impulse is your enemy

3. Buy Right and Hold Tight

Jack kept talking about the importance of asset allocation over and over again. He always cautioned against timing the market and an all-or-nothing approach of being totally in or totally out of the market. He always said that we are better off always being 100% in the market even if it feels like the market is going to zero.

Bogle also recognized how messy and complicated the question of how much to put in stocks and bonds is. He often recommended starting with a 50% in equity and 50% in bonds or putting "roughly your age in bonds." It’s simple as it gets because there is no right answer. The perfect asset allocation can only be known in hindsight.

Starting with a 50/50 allocation is a good place to start compared to not starting investing at all.

The next critical decision you face is getting the proper allocation of assets in your investment portfolio. Stocks are designed to provide growth of capital and growth of income, while bonds are for conservation of capital and current income. Once you get your balance right, then just hold tight, no matter how high a greedy stock market flies, nor how low a frightened market plunges. Change the allocation only as your investment profile changes. Begin by considering a 50/50 stock/ bond balance, and then raise the stock allocation if:
1. You have many years remaining to accumulate wealth.
2. The amount of capital you have at stake is modest (for example, when you make your first investment in a thrift plan or an IRA).
3. You have little need for current income.
4. You have the courage to ride out booms and busts with reasonable equanimity

4. Have Realistic Expectations: The Bagel and the Doughnut

You ask any investor today about return expectations from mutual funds, and 12-15% will be a common answer. A small minority expects nothing less than 20%. This 12-15% is partly because advisors, mutual fund managers and CEOs keep saying the same stupid thing to sell their funds. But I personally think the returns will be much lower over the next decade, and I am also sure I will probably be 99.99% wrong! So the only thing I can do is expect less and save more.

Bogle too stressed the importance of having realistic investment returns and not doing silly things by investing in risky assets like junk bonds (credit risk funds), and increasing equity exposure for higher returns. Sometimes, we just have to accept the lower returns and save more. There’s no magic bullet:

My unvarying advice continues to be to accept the yield environment as it exists (no matter how painful). Most investors should avoid reaching out on the risky limbs of higher-yielding junk bonds and high-dividend stocks.

As suggested a few paragraphs earlier. Invest you must, however, for not investing is an iron-clad formula for failure

5. Forget the Needle, Buy the Haystack

This is perhaps Bogle’s most famous piece of advice. Don’t try to pick the best performing funds or look for “star managers”, just buy the entire goddamn market. Of course, the active fund managers will tell you and show you all sorts of things to convince you that they can deliver.

They’ll tell you they can beat the index. No, they don’t!
They’ll tell you when the markets fall, they can protect the downside. No, they don’t!
They’ll tell you they can time the market and deliver equity-like returns with fixed deposit volatility. No, they don’t!

It’s all bullshit.

Just buy the entire Indian market with index funds. Add simple debt funds. Expect less. Save more. Move on with your life! This is what Bogle said:

When we look for the needle, we seem to rely in our search largely on finding fund needles based on past performance, ignoring the fact that what worked yesterday so often fails to work tomorrow. Investing in equities entails four risks: stock risk, style risk, manager risk, and market risk. You can easily eliminate the first three of these risks simply by owning the entire stock market—owning the haystack, as it were— and holding it forever. Yes, market risk remains. It is quite large enough, thank you. So why pile those other three risks on top of it? If you’re not certain that you’re right (and who can be?), diversify. Owning the entire stock market is the ultimate diversifier for the stock allocation of the portfolio. When you understand how hard it is to find that needle, simply buy the haystack.

6. Minimize the Croupier’s Take

Costs are the biggest drag on the performance of active funds. One of the biggest reasons why they underperform is they charge too much (expense ratios), and they trade too much (high turnover = high costs). This means they end up performing a simple index fund. We had written about the importance of costs earlier multiple times.

A simple example is that a Nifty 50 Index fund charges 0.07%-0.20%, and active large-cap funds charge about 1-1.5%. So they have to generate 1-1.5% outperformance, just to cover the costs and then beat the index. Sounds simple, but The reality is that 60-80% of all active large and midcap funds underperform their benchmarks.

Jack Bogle must have talked about the importance of costs a million times:

The resemblance of the stock market to the casino is hardly far-fetched. Both beating the stock market and gambling in the casino are zero-sum games—but only before the costs of playing the game are deducted. After the heavy costs of financial intermediation (commissions, spreads, management fees, taxes, etc.) are deducted, beating the stock market is inevitably a loser’s game for investors as a group.
So I reiterate that, in the mutual fund industry, you not only don’t get what you pay for, you get precisely what you don’t pay for. Therefore, if you pay nothing, you get everything (i.e., the stock market’s gross return)

7. There’s No Escaping Risk

Let me tell you a secret: The stock market is quite risky. I shocked you again, right? 🤯 You're welcome. I know, my wisdom scares me too!

Look, the market is risky, but investing is a bet on the long-term growth of Indian companies and the prosperity of the Indian economy.

By investing in index funds, you virtually own pretty much all listed Indian companies. The companies that do well become a bigger part of the index, and those that don’t are kicked out. You’ll end up capturing the value that these companies create over the long run.

This is what Bogle said:

Yes, money in a savings account is dollar-safe, but the value of those safe dollars are virtually certain to be substantially eroded over time by inflation, a risk that almost guarantees that you will fail to reach your capital accumulation goals. And yes, money in the stock market is very risky over the short term. But if your portfolio is well diversified, it should provide remarkable growth over the long term. Why? Simply because our public corporations have huge amounts of capital to employ. They earn profits on that capital that can be distributed as dividends, reinvesting the remainder in the business to earn additional returns. So your capital is almost certain to be safer in real-dollar terms over the long term than those “safe” dollars in your savings account.

But to reap the benefits, you’ll have to endure 30% to 60% falls. The objective of investing is to reach your goals like retirement and to create enough wealth to reach those goals; this 👇 volatility is the price.

The objective isn’t to beat the benchmark or pick the best managers.

As I was writing this, Prashanth published this awesome post:

Markets go down every year. That is guaranteed. It’s more in some, less in others but on an average a 10% drawdown is guaranteed while even 20% is possible though in recent years we haven’t really seen one other than the Covid fall. A 30% fall was normal pre-2008. 50% or more happened just twice. Things have changed a lot since 2008.
If you can have and really have and really live by a good long-term investment outlook, that will be close to an investment superpower as you will be ever able to achieve – Cliff Assness

8. Beware of Fighting the Last War

This particular lesson is so timely given all the macro noise.

Read this quote:

We seek technology stocks after they have emerged victorious in the great bull market of the “Information Age.” We worry about high inflation after it becomes the accepted bogeyman, and it then recedes. We flee stocks after the stock market has plunged, and then miss the subsequent recovery. You should not ignore the past, but neither should you assume that a particular cyclical trend will last forever.

Bogle wrote this in 2012, but it might as well have been about today. After the rally of a lifetime, tech stocks, at least in the US, are under pressure and after a decade of noflation, we have serious inflation.

If you listen to the news, you’ll get the feeling that due to inflation, Nifty 50 might become Nifty 0. But just like the good times don’t last forever, the bad times don’t either. Having a solid diversified portfolio with a sensible asset allocation you can live with is the best way to survive all markets.

9. The Hedgehog Bests the Fox

Bogle called financial institutions & investment professionals foxes whose job is to be cunning and make money by overcharging and underdelivering. Perfect description 😂

I agree.

AMCs will always try to convince you that they can deliver double the market returns with half the volatility. They’ll sell you “black box quant strategies”, “innovation funds”, “balanced advanced funds”, “all seasons funds”, and all sorts of garbage. But 70-80% of the funds are doomed to underperform a simple Nifty 50 index fund.

Look, the job of the investment management industry is to take money from you, and your job is to stop that. That starts by ignoring their nonsense.

Keep things uncomplicated and go do something else:

The wily foxes of the financial world justify their existence by propagating the notion that an investor can survive only with the benefit of their artful knowledge and professional expertise. Their assistance, alas, does not come cheap. The costs it entails tend to consume any value that even the most cunning of foxes can add

The hedgehog, on the other hand, knows that the truly great investment strategy succeeds, not because of its complexity or its cleverness, but because of its simplicity and its low costs. The hedgehog diversifies broadly, buys and holds, and keeps expenses to the bare-bones minimum. The ultimate hedgehog is the all-market index fund, operated at minimal cost and with minimal portfolio turnover, which virtually guarantees that you will capture nearly 100 percent of the market’s return.

10. Stay the Course

The ability to stay sane when everybody around you is acting insane is, in my view, a superpower. This means you’ll look like an idiot in the short run because some stupid fund or strategy will be beating the market black and blue. But in the long run, 99% of these funds and managers are shooting stars: they enter with a flash and fade away with a whimper.

The secret to investing is that there is no secret. When you consider the previous nine rules, you realize what they are notabout. They are not about magic or legerdemain, nor about forecasting the unforecastable, nor about betting against long and ultimately insurmountable odds, nor about learning some great secret of successful investing. For there is no great secret. There is only the majesty of simplicity. These rules are about elementary arithmetic, about fundamental and unarguable principles. Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense
As the financial markets swing back and forth, do your best to ignore the momentary cacophony, and to separate the transitory from the durable. This discipline is best summed up by the most important principle of all investment wisdom: Stay the course!

I honestly believe that unless you’re a full-time investor or a fund manager, investing is the most pointless activity in life. There is absolutely ZERO use to constantly fussing about the best manager, the best fund, what some “expert” said, or what some “guru” predicted.

Just buy the entire goddamn market, diversify across Indian stocks, international stocks, have a sensible asset allocation, ignore the market noise and live your bloody life.

Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild. - The Psychology of Money/Morgn Housel