Mr. Bogle responds

I received an reply from Mr. Bogle a couple weeks ago to a letter I emailed him, my email was posted in full here. You can read the reply on his blog under the Ask Jack section [PDF] (see middle of page 4 for the start of my letter). I won’t post his reply in full here because you can read it on his site now, and you can also read a few other questions and comments sent to him. I also didn’t post his reply because I’ve been reading his new book (his “Little Book”) [disclaimer: free copy sent from the publisher], and that’s as good of a reply as anything else. I haven’t had the time to sit down and write the review just yet, but it’s an excellent book – I expected no less – and I’ll have a review of it in more detail in a day or two.

I’ve been recovering from a soccer injury to my hand – I’m a goalie – so I’m typing a little slow right now.

When to sell – the 1 Rule – with a personal experience

The eternal struggle of when to sell stocks and funds has hit home for me. While we’d like this process to be very mechanical, it’s actually very emotional, and that can be dangerous if you aren’t able to control your emotions. Here’s a simple guide to help protect yourself from making silly mistakes or becoming overly emotional (I first set out two rules, then turn them into one rule).

My story is that I’ve been planning a trip with a couple of friends to vacation through Southeast Asia, and it’s about to happen – we’re buying tickets now. One of those friends flies out frequently for work, so he knows the area relatively well, and has a made a number of friends and connections that can help us when we’re there. So, I need to free up some cash so I can buy the tickets as I keep as much as I can invested (and growing) until I need it.

Selling some portion of funds to pay for this, which I’ve been planning, so I know I have the money saved, makes the when-to-sell question quite easy. I sell when I need it, which is rule #1:

Rule 1 – Sell when you need it, not when you don’t. You invest your money for a future purpose, so you should sell when you need to take an action. Remove the environment of the market from the equation as the market doesn’t react to your specific situation.

Now, I hadn’t set a date ahead of time for selling because the plans haven’t been set in stone until a few days ago. The best way to go about this, as it removes as much emotional reaction as possible, is to pick a date as much as a week or two ahead of schedule, and set it in stone through some auto sell-by-date option. You should be able to set a sell date when setting up the sale, but in my case, I just said sell now.

To my fortune, the fund has gained a few percentage points in the last couple of days because the market seems to like the fact that a regularly scheduled FED announcement said they wouldn’t raise interest rates (and probably for a few other reasons too). Had I focused too much on this coming announcement, I may have tried to sell early because I expected bad news, or I might still not want to sell as I planned because I’m reacting to what the market did (either hold longer if I expect more gains, or hold longer because I want to recover from some loss). As you can see, I’d no longer be focused on the reason I actually want to sell, which is my trip, but instead because of expectations I have with the market – expectations that I have no control over or real way of understanding (beyond flipping a coin).

Rule 2 – Don’t plan your sale around short-term shifts in the market. The market doesn’t move around your life plans, so don’t plan around the market. This is when you get emotional because you don’t know what will happen, and worrying about short-term gains (or losses more often) will only lead you into a lose-lose situation. You already have a good reason for selling, so keep your eye on that.

Since this is a blog about removing complexity, and keeping personal finance simple, I’m stopping at 2 rules, and really it could be one rule:

2 Rules as 1: Selling is about planning, not reacting, so sell for a reason like needing the money for a specific purpose or regularly planned rebalancing (if you do this). With the exception of catastrophes (and even then probably not), don’t planning around market expectations because they will bite you in the butt.

To finish, lets assume that I let my emotions take over, and I sold based on my market expectations, and lets also assume I lost money by holding onto the fund after the announcement. Now, I’ve been scarred by this. Humans hate loss, and we do what we can to protect ourselves. Next time there is an announcement, I might feel anxious and want to sell for no reason other than avoiding a temporary loss, which actually costs me money in transaction fees to move the money around, and that’s a loss in itself.

If you go down the road of reacting to the market, the short-term market, then you’ll start to become like many of the traders I used to know who would get anxious, maybe even losing sleep, about potential loss and overconfident about gains both of which they had little control over. Even trying to predict the long term market has big risks, which is why holding the whole market is in most cases the best option (in both risk and return).

Back to the basics

It’s been a little while since I last posted (been sick part of this time), and my last few posts have been a little heavy, or involved, or however you want to describe them. So, to get back to the basics and just keep it simple, here’s a simple reminder of what personal finance is all about.

At the end of the day, it’s all about you, not a number in your bank account(s). It starts and ends with you. You hopefully work at a job that you like, and that makes you some amount of money that’s more than you need to spend. With the money left over, you put some of it into a checking or savings account. As that amount grows, you move some into a retirement account or into an investment account. Both will use index funds as an investment option, and later on down the road, at retirement, or when you buy a house, or make some other purchase that needs this money, you cash out.

That’s it. That’s the whole system easily summed up in one short paragraph. You could get a little more detail on the index fund question, but you go out and buy the whole market. Don’t mess with the extra costs, risks, and complexity of doing it any other way. Maybe you tweak how you buy the whole market, and include different allocations of bonds and equity such as with a mix of US and foreign equity, but you’re not picking and choosing winners and losers. You’re picking a very competitive market return (a better return than from active mutual funds, or picking stocks yourself) with low costs and an easy conscious.

The hardest part of this is planning your future. What do you want to do, and what do you need to do it? Your money only supports your lifestyle, it doesn’t choose it. You can easily make this more complex, but why? That really is all you need, and maybe you have one index fund period. That makes where you put your money beyond easy, it’s brain dead. And then you really focus on being able to save and invest in that one fund. You worry about what you’re planning on doing with the money, and not what your money does. That is simple, elegant, and beautiful.

The bank of the future – Apple + Starbucks

Banks suck. How many people go into a bank and are in any way excited about the bank itself? No one…thought so. You may be excited about withdrawing some money for a cool new purchase like a house or a special vacation, but no one goes to a bank to just be at a bank. Why is that, and why do I expect most people to think that’s a completely stupid idea – “going to a bank to hang out at a bank? Absurd.” Or, is it?

People do goto Apple stores and Starbucks shops (or Peet’s if you prefer) just to be at those places. Yes, you go there because of the product too, an iPod or some coffee, but I know plenty of people who goto Apple stores just to play around with what’s there, even if they already have that same thing at home. And, I know people who goto Starbucks to just buy a cup of coffee and chill at that “third place” as Howard Schultz likes to call it. Banks are losing out by not building themselves around this experience too.

Why don’t we have banks like retail stores that are as interesting or thought provoking as the products themselves (which comparing to Apple, they didn’t have until recently either, but look what that did for their business)? Because, as I keep repeating, it’s too much about the physical (or digital) money when it needs to be about the result of having that money, and I’m not just talking about an annual return.

Credit unions are nice (and much preferred over a traditional bank), but why don’t we have the mountain biker’s credit union that does more than allow membership for mountain bikers? You can join a credit union for actors if you can show that you’re an actor, but what does that credit union do beyond offering cheaper-than-bank offerings for some savings and possibly investment options? Nothing, and why not? Why doesn’t that credit union or bank also cater to the needs and interests of a mountain biker beyond his savings and portfolio needs? That money is being put away for a reason. This mountain biker is more than just a client or a generic investor, but who’s reaching out to really understand that person?

Thanks to the guys at 37Signals who write Signal vs. Noise, I was linked to this insightful article about the thought process and construction of Apple stores. Some excerts:

“Ron and I had a store all designed,” says Jobs, when they were stopped by an insight: The computer was evolving from a simple productivity tool to a “hub” for video, photography, music, information, and so forth. The sale, then, was less about the machine than what you could do with it.

“Less about the machine…” For a bank, less about the money, less about the return and more about “what you could do with it.”

When the first store finally opened, in Tysons Corner, Va., only a quarter of it was about product. The rest was arranged around interests: along the right wall, photos, videos, kids; on the left, problems. A third area – the Genius Bar in the back – was Johnson’s brainstorm.

As in the previous quote, what is the product of a bank? The product is where the bank makes it’s money, but that’s not where the customer’s experience ends, so why are banks structured around the product and the sale of that product?

Johnson is telling the story as he walks the floor of Apple’s San Francisco store, a perfect stainless-steel box punctuated by a massive skylight, which is throwing sun on a thirtysomething couple getting a tutorial at the Genius Bar. “See that?” says Johnson. “Look at their eyes. They’re learning. There’s an intense moment – like when you see a kid in school going ‘Aha!'”

Has anyone seen that kind of experience in a bank? Some banks will have counters with employees that try and help educate you (sometimes you have to pay, and sometimes you don’t), but those are there specifically based around the product still.

“Apple has changed people’s expectations of what retail should be about,” says Candace Corlett of WSL Strategic Retail in New York. “After they’ve seen Apple, how do they feel looking at a drugstore or the jeans section in a department store?” Other companies are asking themselves the same question.

“…asking themselves the same question,” so what about banks? I could find similar articles for the construction and thought process behind Starbucks stores where they’re basically de-emphasizing the product, and emphasizing the experience, which in Starbucks’ case, often has little to do with coffee itself – remember, it’s based on the “third place” experience.

Now, not all banks have to have a cool experience. Many times is really is just about the money and an annual return, but why don’t we have options beyond that? Give the customer control over the experience because they already have that anyway. Don’t force them to be a generic customer/client/investor, but give them a space to spread out in and lay around. A space where they can dream about possibilities, plan for those possibilities, make connections with others of similar interests, and get educated freely around that. They’ll still buy your product, but they’ll spend most of their time thinking about themselves (or their goals) as they should be, and less about the bank or the money. And with more people “hanging out” at your location (which just happens to be a bank), you’re sure to draw them to your products and services because you’ve shown them that your values, or as previously posted your corporate soul, and those match with their own.

In one of John Bogle’s speeches that I read, he said that fees and costs were the only differentiating factor between mutual funds (which is really the only difference today between credit unions and banks). So, the lowest cost and lowest fee funds should win, but that doesn’t mean that’s the only thing fund companies should be about. There is more to the experience than that, and we have yet to see anyone capitalize on it like Apple or Starbucks have in their own industries. Understand customers’ interests and values, and help them achieve those without too great of focus on yourself.

Stop investing in US equities – China, the housing market, and consumer confidence – oh my.

Long title, I know. I’m not actually advocating a withdrawal from US equities based on some belief about the impact from China, the housing market, and whatever else. I’m just drawing attention to silly arguments. These come up all of the time, especially with the recent market drop and accompanied frenzy from certain cirlces. The problem is that such reasoning is like playing a 6 degrees of separation game based on an expectation market of global politics, market indicators, etc., and not on the real intrinsic value market of real companies with real products and services. As Ramit at I Will Teach You To Be Rich puts it, “These are not the reasonable conclusions of someone who’s informed about personal finance, but someone who’s cobbled together a shaky theoretical framework that ties personal finance, global politics, and entrepreneurship together.”

We’re accustom to thinking about the market through our expectation of a certain level of return in a broad sense. However, that doesn’t mean you can get a jump on future market changes and exploit some change for your own profit in a specific, planned, and guaranteed way. I’ve discussed the efficient market hypothesis before, but it’s even simpler than that. Markets are made up of companies that provide a real service or product in the hopes of profit. Global politics, consumer savings rates, and such may impact the flow of goods and services, but they don’t substantially change the underlying markets and companies, and being worried about the recent dip in the US market, which also occurred in foreign markets, doesn’t mean that you should get out of the US market.

The market works by pitting multiple companies against one another, and some will go out of business from that (good), and some will thrive because of that (good). The strength of the US market is derived from the companies that make up that market like GE, Microsoft, and Walmart. The strength of these companies is based on the people they hire and the innovations they create. Unless there is some great shift from that situation where a foreign company also takes the lead (like Toyota pounding previous auto industry leaders like Ford and GM), then you are very safe keeping your money in the US market. And even then, on average, US companies are still fighting hard and well against the competition.

Thinking about the large growth in some foreign markets like China and India may make you anxious, but you should realize that 1) growth is inversely related to return (and return is what we as investor really care about), and 2) even with substantial growth, the US economy and markets are massive in comparison, and 200% growth for India is worth half a percent of growth in the US. That doesn’t mean that foreign markets and companies aren’t good investments, but there seems to be a persistent pessimistic sense of doom for the US economy and market. That’s nothing new, and that might even be a good reason why the US economy is so strong as companies are always on the lookout for failures and opportunities.

There are two more final reasons why you shouldn’t fear foreign market growth, but actually hope for it. First, growth in foreign markets is good for the US market and investors. This is a pie getting bigger scenario, and not a fight for the same pie. Also, increased competition forces companies to compete that much better, which leads to the second reason for not being afraid; No other market is as well established as the US market for that kind of pressure.

As I said already, the American market is built on American companies that hire the right people, which includes foreigners. This is so easy in the US because of the vast number of universities including a large number of world class universities and their high concentration in areas like the Silicon Valley and Boston (the two leading world entrepreneurial hot spots). These mental hot spots breed good ideas, and draw smart foreigners as much as they draw smart locals, and they’re drawn into a culture that values and supports entrepreneurialism. Additionally, these areas are supported by very experienced, wealthy, and competitive corporate and private funding industries (think venture capital). Being able to draw these three key factors into one if not multiple spots like in the US, or elsewhere, takes tremendous time and effort as it takes time to establish good schools, a good encouraging culture, and the money to support both.

When you feel the urge to make 6 degrees of separation reasoning, take the time to think about the above factors, and decide if anything fundamental has actually changed. Most likely it hasn’t, and on top of that, I’d be surprised (no offense to the anonymous reader) if you actually had a clue what it means to the market when Japanese confidence in the US is low, and how that impacts the US housing market, and by “direct” reasoning means the US market is doomed. Very smart people make these statements every day having no idea what that really means if they’re even able to make it sound sensible. Trust the market as a whole, and be confident in the long term sustainability of the US market and economy. Even the UK, which was the world leader before the US, is still a very strong market and economy after having lost its spot to the US. So, keep saving and investing as usual, and don’t listen to kooky and conspiracy theory reasoning.