Home Wealth  Money With Future Returns Likely Lower, Taxes And Investment Expenses Loom Large

With Future Returns Likely Lower, Taxes And Investment Expenses Loom Large

Posted: Oct. 23rd, 2010  |  By Forbes

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One by one they stood up and introduced themselves, the couple who traveled from London, the doctor from Pennsylvania, the former firefighter who retired to Florida, the young employee just starting his career, and the widow.

Who are these people who came together to spend three days in Philadelphia last week? Meet the Bogleheads--followers of the common-sense investing advice of John C. Bogle, the founder of The Vanguard Group, the largest mutual fund company in United States, according to the most recent data from the Investment Company Institute. Interestingly, these strangers met on the Internet through privately run, not-for-profit financial discussion forum www.bogleheads.org. Each year a few of them gather in person to swap life stories, match faces to Internet names, talk about investing, and to spend time with John C. Bogle (Jack as he likes to be called.)

Members of this group don't look for get-rich-quick schemes, or spend time swapping tips on hot stocks. In fact, many of them are already very wealthy because they have followed sound basic financial principles for their entire lives--live below your means, diversify your investments broadly, use only low-cost investments, and stay the course. They don't know what the stock market is doing at any given moment, and they don't care because their investments are timeless and are held for the long term. They are "The Millionaire Next Door" as described in the famous book by Thomas J. Stanley and William D. Danko. Not everyone in the group is a millionaire but most will certainly achieve that goal someday.

Having attended the event for the last four years, it is always interesting to me to see how the topics of discussion are swayed by current news events. This year low interest rates, the effect that rising rates will have on bonds and the amazing run-up in gold were favorite topics of discussion. Bogle reminded the group that when everyone is talking about a particular "can't lose" investment like gold, that is usually the sign of trouble. (Remember when any Internet business was a guaranteed winner or when real estate value increased 10% per year with no risk?)

Many people were worried about bond returns in the future, with interest rates and yields so low now. With almost no room for a further decline in rates, it is more likely that the future will see rising rates. While those higher rates would provide more income for retirees dependent on bond income, the rise in rates also brings bad news for individual bond and bond fund investors. The key to understanding what will happen with bond or bond funds is to understand the duration of the fund. On the Vanguard website the duration of bond funds is easily accessible. The website also defines duration as "a measure of the sensitivity of a bond and bond mutual fund prices to interest rate movements.

For example, if a bond has a duration of two years, its price would fall about 2% when interest rates rose one percentage point. On the other hand, the bond's price would rise by about 2% when interest rates fell by one percentage point." The last decade of falling interest rates meant terrific returns for bond investors. Will the next decade see a further decline of interest rates? Probably not. Does this mean that investors should avoid bonds? No. Bonds provide stability and income in a portfolio and help to reduce risk. They remain a critical part of a properly allocated portfolio. Investors who need their money in a short period of time should invest primarily in short-term bonds or bond funds. Investors further from retirement or who will not need the money for several years could invest in intermediate term bonds with the understanding that the value of the holdings will be reduced if interest rates rise. But remember, earnings from the bonds can be reinvested at the new, higher rate of return so the actual reduction in the initial value will eventually be offset by higher rates.

Jack Bogle and other experts on hand, like financial advisors and authors Bill Bernstein, Rick Ferri and Bill Schultheis, and Dr. Ed Tower from Duke University all agreed that future returns were likely to be lower than historical rates of return. To maximize personal investment return, minimizing taxes and expenses in investing will be critical. Money saved through low costs remains in the investment portfolio and grows to the benefit of the portfolio owner. The Vanguard Group is recognized as the low cost leader in the investment industry and has a unique structure where the fund investors actually own the company. It is almost a not-for-profit company and Vanguard investors benefit from a corporate culture of cost consciousness. Jack Bogle humorously and proudly pointed out that Vanguard's profit was $0 while a competitor had profits of $2.6 billion. On a serious note, that $2.6 billion represents money that is no longer held by the investors who entrusted their financial future to the firm and will not benefit the portfolio owner.

This year The Vanguard Group hosted the Bogleheads for a special evening event with senior Vanguard executives. Throughout a question and answer session with them, it quickly became obvious that all decisions at Vanguard are made with the value to the customer and costs in mind. As a Vanguard investor I left feeling that the company culture worked to benefit me and my family. Low investment expenses, a broad selection of passive and active low cost funds, and a corporate culture focused on maximizing value to the customer while taking the lowest investment risk. What more could you want in a firm responsible for helping you achieve long term financial success?

The Bogleheads will come together again next year, but you can join the lively discussions now at www.bogleheads.org. Even Jack Bogle himself posts there from time to time, and his recent message to attendees says it best of all. "Your warmth, your investment savvy, and your focused interest in the investment strategies and human values that I established at Vanguard's founding all those years ago, gave me great joy, and even some satisfaction (although it's still too early to allow myself much of that!) ... You are some remarkable group, not only in terms of your common sense and intelligence, but with your warmth and affection."

Laura F. Dogu is a co-author of The Bogleheads' Guide to Retirement Planning along with Taylor Larimore, Mel Lindauer, and Richard Ferri, and is one of the leaders of the online Bogleheads www.bogleheads.org.




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