The ideas behind Boglehead’s investment philosophy(1) came from John Bogle, the founder of Vanguard. The principles are underpinned by research on Modern Portfolio Theory(2) and the resulting Capital Asset Pricing Model(3). Broadly,this research shows that when choosing between 2 investment portfolios with similar returns, an investor will always prefer the portfolio with the least risk. If the investor wants more return, he or she will have to take more risk.
Bogleheads investment philosophy follows 10 simple principles :
- Develop a workable plan
- Invest early and often
- Never bear too much or too little risk
- Diversify
- Never try to time the market
- Use index funds when possible
- Keep costs low
- Minimize taxes
- Invest with simplicity
- Stay the course
In the blog post The 10 Principles of the Bogleheads Investment Philosophy (Part 1) I explain the first 5 principles, today I explain the last 5 principles to you.
Use index funds when possible
An indexfund or ETF (Exchange Traded Fund) is an investment fund which is (usually) based on an index. A stock index is the weighted average of several important stocks. Examples are the Belgian BEL20 index, the American S&P500 index and the Dutch AEX index. The provider of an ETF, such as Vanguard and Blackrock, buys and sells shares/bonds based on their weight in the index.
John Bogle founded The Vanguard Group in 1975, where he created the first index mutual fund (the current “Vanguard 500 Index Fund” based on the S&P500 index).
Bogleheads invest in globally diversified index funds/ETFs.
Keep costs low
When investing in ETFs there are also costs involved, costs linked to the broker and costs of the fund.
Some brokers charge monthly recurring costs, such as custody or management fees. Try to avoid these monthly costs as much as possible!
For each purchase or sale of securities, the broker may charge you transaction costs. These costs differ from broker to broker and depend on the purchase or sale amount and the stock exchange where the security is listed. Most European ETFs are traded on Euronext Amsterdam, XETRA, London Stock Exchange and Borsa Italiana.
Actively managed funds charge between 1% to 2% per year … every year. This eats into your returns tremendously.
The provider of a passive ETF charges shareholders an expense rate to cover the operational costs of the fund. Here, I’m aiming for a maximum annual percentage rate of charge, also called Total Expense Ratio (TER), of up to 0,50%.
In the long term, you are more likely to get a better return from a passive investment than from an active investment portfolio(4).
Minimize taxes
In Belgium, we pay taxes on stock exchange transactions (TOB) and taxes on dividends/coupons. To minimize these taxes, take the following criteria into account when selecting an ETF:
- Accumulating : in Belgium we pay 30% withholding tax on dividends/coupons. An accumulating ETF reinvests the dividends/coupons, and therefore you don’t have to pay this withholding tax.
- Domiciled in Ireland : Ireland does not tax foreign investors on dividends/coupons.
- Not registered in Belgium : Belgians pay a lower tax on stock exchange transactions (TOB) for each purchase and sale of funds that are not registered in Belgium but are registered in a country of the European Union.
You can find all other selection criteria in my blog post How to choose the right equity ETF and An introduction to bond ETFs.
Invest with simplicity
You don’t need many funds to be diversified. Preferably, one world diversified equity ETF and one bond ETF. If your risk profile allows, you can also invest only in a stock ETF, without using a bond ETF.
There are several advantages to simplicity in your investment portfolio. You can analyze and interpret the portfolio more easily, and it is less complex to rebalance, this is to bring the distribution of shares/bonds back to the right level after a rise or fall of the stock market, as defined in your financial plan.
Stay the course
The last principle is also the most difficult. If the stock markets are doing well, it is easy to stay on board. But the danger lies in poorly performing stock markets. Many investors then panic and sell (part of) their investments.
It is easier to stay on track if your asset allocation, this is the distribution of equities/bonds, based on your risk profile is right. If you are sleeping poorly in a bear market it usually means that you are investing too much in equities.
During or after a bear market (stocks show a downward trend) or bull market (stocks show an upward trend) this asset allocation becomes unbalanced. Bogleheads solve this by rebalancing.
How does this work?
Suppose you have established an asset allocation of 80% stocks and 20% bonds in your financial plan.
- After a decline in the stock markets, this asset allocation became 60% stocks and 40% bonds. To bring your asset allocation back in balance, you rebalance by selling part of your bond ETFs and buy equity ETFs for the same amount. After rebalancing, your asset allocation will again be 80% equities and 20% bonds as defined in your financial plan.
- After stock markets rose, this asset allocation became 90% stocks and 10% bonds. To bring your asset allocation back in balance, you will rebalance by selling part of your equity ETFs and buy bond ETFs for the same amount. After rebalancing, your asset allocation will again be 80% equities and 20% bonds, as defined in your financial plan.
Timing for rebalancing is a personal choice. You can rebalance at a fixed time, for instance once a year, and your birthday is a common choice. You can also rebalance if your shares or bonds deviate a certain percentage from the asset allocation determined in your financial plan.
This info is for informational, educational and entertainment purposes only, and does not constitute financial, accounting, or legal advice. Please do your own research (disclaimer).
Sources :
(1) Bogleheads® investment philosophy – Bogleheads. (n.d.). Bogleheads. Consulted on 2021, August 13, https://www.bogleheads.org/wiki/Bogleheads%C2%AE_investment_philosophy
(2) Wikipedia. (2021, July 7). Modern portfolio theory. Wikipedia. https://en.wikipedia.org/wiki/Modern_portfolio_theory
(3) CAPM – Capital Asset Pricing Model – Bogleheads. (n.d.). Bogleheads. Consulted on 2021, August 13, https://www.bogleheads.org/wiki/CAPM_-_Capital_Asset_Pricing_Model
(4) S&P Dow Jones Indexes. (2021, 11 maart). SPIVA U.S. Scorecard Year End 2020. www.spglobal.com. https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2020.pdf