The thin green line
The thin green line is the elusive line you must cross to get your fair share of stock market returns. What’s fair share, you ask?
Your fair share is the average returns provided by the stock market.
You might think it shouldn’t be difficult to get average, but accounting for costs and behavioral mistakes, it is really very difficult. After 20 years investing, more than 80% of investors won’t cross the thin green line. and without an extraordinary gift from John Bogle, you would not even have the chance to get your fair share.
John Bogle’s gift
In 1975 John Bogle, with the sole intention of providing a way for investors to get their fair share, created the Vanguard mutual fund company . Mr. Bogle created Vanguard as the only not-for-profit mutual fund company in the world, and it remains that way today. In fact, Vanguard is owned by the mutual funds it provides and therefore, it’s owned by the shareholders of those funds. This means the mutual funds offered by Vanguard are operated at cost, there is no company profit.
Shortly after the creation of Vanguard, Mr. Bogle completed his gift to the individual investor by creating the first low-cost, no-load index fund, the S&P 500 index fund. The S&P 500 index, as it is constructed today, was created in 1957, but there were no low-cost funds available to track it until Mr. Bogle created Vanguard almost 20 years later.
Today, there are several mutual funds that track the S&P 500, and other funds like the total stock market index and total international index are now available to help you get your fair share, but if it weren’t for John Bogle’s gift, there would be no way to get your fair share of market returns.
The classic, capitalization-weighted index fund that faithfully tracks the market is the only investment that guarantees you will have the opportunity to cross the thin green line and get your fair share of stock market returns.
Note: If you are familiar with the Bogleheads investing forum, you may have noticed a lot of participants with high incomes and large amounts of assets. Don’t let that confuse you. John Bogle’s dream was to provide a way for the average investor to cross the thin green line and get his/her fair share, and there is no better or more efficient way for the average investor to do it.
Major barriers to crossing the thin green line.
Notice that above I said low-cost index funds guarantee the opportunity to cross the thin green line. Crossing the line into the green is not difficult in the mechanics thanks to the creation of very low-cost index funds, but in reality it isn’t as easy as it appears. The opportunity is often wasted by behavioral errors.
The records show that investors as a group do not get the returns of the funds they are invested in, and it’s largely due to diverging from the strategy of simply buying index funds and holding them.
In addition to behavioral hurdles, investors reduce their chance of crossing the thin green line by using individual stocks and actively managed mutual funds. As noted above, more than 80% of investors do not cross the line and most of them are using actively managed funds.
There are two reasons for this: one is higher costs, and the second is inconsistency in the investment strategy and implementation inherent in active funds. So, while using active funds might give you a 20% chance of exceeding the thin green line, it also give you an 80% chance that you won’t reach it at all. Remember, Bogle’s gift guarantees you will cross the thin green line if you don’t make behavioral errors. No other investing method can claim that.
The lure of academic research
If you have looked into the academic work on investment returns, you might be familiar with the factors that help explain market returns. For instance Fama/French show that small cap stocks and value stocks produce higher returns than the overall market. If you think this is a clever way to improve upon the return and easily cross the thin green line, think again. These factors introduce additional risk, and because of that, and the fact they encourage tweaking and promote questionable behavioral activity, they incorporate a possibility that you may fail to reach the thin green line, much less exceed it. If you want to incorporate some of these factors into your investment plan, be sure you fully understand the inconsistencies and deviation from market performance they introduce.
From the inside flap of John Bogle’s book, The Little Book of Common Sense Investing:
Investing is all about common sense. Owning a diversified portfolio of stocks and holding it for the long term is a winner’s game. Trying to beat the stock market is theoretically a zero-sum game (for every winner, there must be a loser), and after the substantial costs of investing are deducted, it becomes a loser’s game. Common sense tells us—and history confirms—that the simplest and most efficient investment strategy is to buy and hold all of the nation’s publicly held businesses at very low cost. The classic index fund that owns this market portfolio is the only investment that guarantees you your fair share of stock market returns.
Average investors are far better off following Mr. Bogle’s simple strategy because it provides the needed lowest cost, reduces the tendency to make behavioral errors, and offers an excellent chance of crossing the elusive thin green line.
Here is an example of a recommended portfolio that meets the requirements.