Remarks by John C. Bogle, Founder and Senior Chairman,
The Vanguard Group
Before the Philadelphia Chapter of the American
Association of Individual Investors
November 23, 1999
Good evening. It is a very special privilege to be here
with you tonight, all the more so because you have graciously agreed to let
bygones be bygones and forgive me for the abrupt cancellation of my previously
scheduled appearance on November 5, 1995, just four years ago. But since then
I've had a change of heart. So here I am.
Some of you insiders may know that I really have
had a change of heart. I entered Hahnemann Hospital in Philadelphia on October
18, 1995, to await a transplant, and, after a 128-day wait, received my new
heart on February 21, 1996. I hope it will be obvious that my new heart, young
and strong, has given me not only boundless energy, but a wonderful outlook
qualities that have enabled me to face adversity with a smile,
and to put the problems of the past just where they belongin the past.
Given a second chance at life, I accept more enthusiastically than ever before
the challenge Kipling laid down for those who "face both triumph and disaster:
To treat those two imposters just the same." So I intend not to dwell on the
past, but to look to the future, keeping an eagle eye on the interests of
Vanguard, our crew, and our shareholders; and energetically continuing my
mission to give mutual fund investors everywhere a fair shake. As I tell our
Vanguard shareholders in this year's annual reports: "
I have promises
to keep, and miles to go before I sleep. And miles to go before I sleep."
But it is not my nonappearance before
you in 1995 that sets the stage for my remarks this evening, but my previous appearance before the Philadelphia Chapter of AAII.
That speech took place on September 27, 1988, in an investment environment
that is such a contrast from our current environment as to constitute the
difference between day and night, or, more appropriately, between night and
day. Since then, we have enjoyed one of the finest economic eras in America's
long history, raising the question Cervantes asked 400 years ago: Can we ever have too much of a good thing?* To tip
my hand, I'll tell you later that I think the answer to that question may
*In Don Quixote, Cervantes gave us
an astonishing variety of phrases that have enriched the lexicon of investors.
I've used eight of his most familiar sayings in this talk.
Economics and Emotions
Twelve years ago, cautionor even worsewas the watchword
for investors. The Dow Jones® Industrial
Average had suddenly dipped by 35%from 2700 in August 1987 to 1700
in October 1987with 523 points of the 1000-point drop coming on Black
Monday, October 19, 1987. A year later, when I talked to you, the market had
retraced but half of the lost ground.
It was at this point that TIME magazine
wrote a frighteningly bearish article (accompanied, of course, with the obligatory
illustration of an enormous bear) that I used as the theme of my remarks to
you. My talk had this lengthy title, which I pulled from the TIME
Buy Stocks? No Way! It's a dangerous game
It's a vote of confidence
that things are getting worse
The market has become a crapshoot
The small investor has become an endangered species
The stock market
is one of the sleaziest enterprises in the world.TIME reported that the percentage
of individual investors with immediate plans to buy more shares had plummeted
from 35% at the August 1987 market high to just 3.7% in September 1998. But,
both as unshakable optimist and market contrarian, I assured you that, with
the Dow at 2080, the articlealong with many similar articles I'd read
after that Great Crashwas "far more likely to be a sign of investment
opportunity than a harbinger of Armageddon."
A nice prophesy! For that was nearly 9000 points ago. Today the Dow
rests, seemingly comfortably, near the 11000 mark, a mere 450% higher than
when I spoke to you then. But, as TIME's
survey of investors' intentions suggested, few investors indeed took advantage
of the fantastic investment opportunity that lay before them at that moment.
Investors had purchased $25 billion of equity
mutual fund shares when stock prices were high during the first seven months
of 1987, but liquidated $4 billion of their
fund holdings when stock prices were cheap during the first seven months of
I have spoken often of the clash between economics and emotions in investing.
By economics, I refer to the strength of our U.S. economy, the nation's remarkable
capacity for innovation and growth, and the resilience of our financial markets.
By emotions, I refer to our all-too-human tendency to be frightened at market
lows and then brimming with confidence at market highs. Emotions too often
stand in the way of our making sensible economic decisions, a counterproductive
element in investing that rarely has been more evident than in 19871988.
That may seem like ancient history to you, but to me it was "only yesterday,"
and holds lessons for us this evening that are every bit as relevant as they
were eleven years ago.
If the idea is to keep our counterproductive emotions out of the productive
economics of investing, there are two key decisions on which investors must
focus. One is, of course, the allocation of your investment assets, essentially
between stocks and bonds. I can't do much more here than repeat what I said
eleven years ago about the proper balance: "It all depends."
It all depends on the magnitude of your accumulated assets, your financial
liabilities, your investment goals, your tolerance for risk, your need for
income, and your age
perhaps a 50/50 balance as the starting point,
less in stocks for a cautious investor age 65 who's just retired; much moreperhaps
even 100% in stocksfor a carefree younger investor just beginning with
an IRA or corporate thrift plan. But I acknowledged then, and I reaffirm now,
that if you think, as Cervantes did, "It is good to
keep your nest egg," you need to take into account not only the
risk of investing, but the risk that your emotions may intrude even on the
soundest of plans. I confessed then that I could not measure "your psycheyour
patience, your independence, your determination, in all, the strength of both
your heart (There, I've said it again!) and your stomach to press on, no matter
how compelling the immediate case for abandoning your plan." But, eleven years
later, in a far more bullish environment, those factors remain critical considerations.
"A Needle in a Haystack"
The other key decision and my main focus tonight will be the selection
of common stock mutual funds for your portfolio. And it is here I come to
my title theme: "The Needle or the Haystack?" It was Cervantes who warned
us, "Look not for a needle in a haystack."
While that phrase has become deeply imbedded in our language, however, it
has yet to gain acceptance from most mutual fund investors. Most of us spend
countless time and effort poring over fund records, getting information from
news articles and television interviews and friends, from hyperbolic fund
advertisements and well-intentioned fund rating services. In substance, all
of these statistics describe the past returns of mutual funds with decimal-point
precision, yet have no predictive power to forecast the future returns a fund
may earn. As it turns out, we are looking for a very small needle in a very
How likely is it that you will find that elusive needle in the now-3500
stock fund haystack? The chances of picking winning funds or managers are,
well, awful. And not because there are a horde of charlatans out there, though
there are some. It is because time and again, looking backward leaves us,
as the kids would say, "clueless." And children don't mean that in a complimentary
sense. Let me give you some anecdotal evidence.
First, let's take a long-term look at your chances of finding the needle.
Following Cervantes' advice that "Honesty's the best
policy," I'll go back 30 years, to the end of 1969, to provide
a fair perspective that includes not only the past two golden decades, but
the tin decade of the 1970s. There were 355 stock funds in the market haystack
at the outset. Astonishingly, 186 of themmore than halfhit the
hay, metaphorically speaking, going out of business during the period. Of
the 169 funds that remained for our analysis (doubtless, the better performers),
the average return was 11.5% per year, 2.1 percentage points behind the 13.6%
annual return of the total stock market.
Source: Derived from data provided by Lipper Inc.
Only nine funds beat the aggregate return on the U.S. stock market by
more than 1% per year. We'll describe them as the winners. Another 18 beat
the market return by less than 1%, and 29 fell short by less than 1%, a group
of 47 funds that we can describe, more or less, as market-matchers. That left
113 funds that fell behind by more than 1% annually. We'll describe them as
the losers. They include 39 funds which fell more than 3% a year behind the
marketpoor losers, as it wereincluding 25 that fell an utterly
unacceptable 4% or more behind, and two that actually posted negative returns.
(And they're both still in business!)
All told, your chances of owning a fund that survived were less than
50-50. If you were one of the lucky ones whose fund made it through the period,
the chances it was a loser were seven in ten; the chances it was a bomb, one
in four, and the chances it was a winner but one in 19if we count the
number of funds that began the period, only one in 40! The odds of finding
the winning needle in the fund haystack were fraught with peril; the odds
of finding a losing needle rife; and the odds of losing the needle itself
the largest of all.
Can an Expert Find the Needle?
But, you ask, can't the experts help us to pick the winners? The evidence
is almost universally discouraging. Let me give you just two examples. One
is the highly respected Morningstar Mutual Funds
rating service, well-known for its award of "Morning-stars." They award five
stars to the highest-rated funds, one star to the lowest-rated funds. So,
playing on Warren Buffett's idea that investment managers should eat their
own cooking, let's examine the funds Morningstar
initially selected in 1991 as the investment options for the 401(k) Thrift
Plan they offer to members of their own staff. Surely, this is where their
expertise should find its proudest fulfillment. Indeed, they argue that "we
should know a thing or two about picking funds." They selected 13 equity funds,
a diverse group that included U.S. large-cap and small-cap funds, specialty
and international funds alikea wide range of choices that gave their
employees "an expansive choice of top-rated funds."
Morningstar's 401(k) Funds vs. The Total Stock Market, 19911999
Source: Morningstar, Vanguard Research.
But, alas, the past was not prologue. Despite Morningstar's unarguable
expertise, nine of their 13 choices have lagged the market, and their selections
have earned an average annual return of 15.3% since the outsetfully
2.8 percentage points per year behind the 18.1% return of the stock market,
a cumulative shortfall in return of 80 percentage points (+172% versus +252%).
That performance gap versus the market was even worse than the 2.1 point gap
experienced by the fund survivors of the past three decades. Fund selection
expertise, it seems, is not so easy to come by.
New York Times Advisers Performance, 19931999
Average of five advisers
Adviser percent of fund return
Avg. annual return
% of S&P 500®
Source: New York Times, Vanguard Research.
But if the experts of 1991 fell short of the market by an even larger
amount than did the average fund chosen 30 years ago (although we have no
way of knowing the results of the 186 funds that failed to survive), the experts
of 1993 did even worse. In mid-1993, The New York
Times asked five professional financial advisers to select and
manage a $50,000 "paper portfolio" of mutual funds, with the goal of outpacing
the target chosen by the Times: an index
fund modeled on the Standard & Poor's®
500 Stock Index. From personal experience, I can tell you that these were
anything but fly-by-night advisers. They are competent and experienced, among
the best in the field. Yet, by October 1999, some six years later, not a single
adviser had provided a return that even came close to the 21% annual return
achieved by the target index fund. The fund portfolio of the average adviser
provided an annual return of just 13.8%, more than seven percentage points
behind. The closing value of the initial $50,000 paper stake The
New York Times provided each participant with at the outset: Average
adviser, $112,000; Index fund, $164,000. Shortfall: $52,000. What an illuminating
test of the challenge of equity fund selection! The experts, once again, proved
utterly unable to find the needle in the haystack.
Why So Many Losing Needles? Costs!
What has caused those consistent and ghastly shortfalls of fund returns
relative to the market? Fund costs. It turns out that the average fund manager
simply matches the market return, before the deduction of costs, and, I should
add, before taxes. We now have very good 15-year figures (from Morningstar
Mutual Funds) on the impact of taxes, so to reinforce my point,
I'm now going to evaluate mutual fund returns during the past 15 years and
show you the combined toll that costs and taxes have taken on fund returns.
During that period, the market's return was a generous 16.9% per year. Now,
let's see the bite that costs took out of it:
- First, fund sales charge costs.
Fifteen years ago, most funds were purchased on a "load" basis, with front-end
sales commissions then averaging about 6%. Amortized over the period, that
cost came to about 0.5 percentage points per year.
- Second, fund opportunity cost.
Equity mutual funds typically held cash positions equal to about 7% of assets,
earning the short-term interest rate rather than the higher returns available
on stocks. Result: a return sacrifice of about 0.6 percentage points per year.
- Third, fund transaction costs.
Portfolio turnover costs that funds incurred in buying and selling stocks
amounted to at least 0.7 percentage points during the period. (These costs
are not disclosed to investors.)
- Fourth, fund operating costs.
Fund expense ratiosmanagement fees and other operating expenses, all
charged against fund returnscame to 1.2 percentage points per year.
Annual Investment Returns, 19841999
Average mutual fund
Sales commission, 6% (annual impact)
Investor return (after tax)
Reduction of equity return
Source: Morningstar, Vanguard Research.
Together, these costs come to 3.0 percentage points annually, exactly
equal to the 3.0 point gap13.9% between the average fund's reported
return of 13.9% and the 16.9% return of the stock market. That gap is not
materially different from the 2.1% gap over the past 30 years and the 2.8%
gap of the Morningstar retirement plan, and less than one-half of the shortfall
of The New York Times-selected advisers.
So we're seeing some fairly consistent, if not conservative, data.**
The message: In a stock market in which prices are established by the
interaction of smart buyers and smart sellersfund managers, pension
managers, financial advisers, stockbrokers, and certainly most
individual investorsthe average fund manager proves to have average
stock-picking ability, a finding that falls well short of astonishing! Nonetheless,
even the fund manager who beats the market by 3% per year before
costsno mean achievementwould end up, after costs,
with only average returns. And, the manager who wins
by 3% before costs must be counterbalanced by another manager who loses by 3%. So the loser ends up, after
costs, falling behind the market by 6% per year. The appalling, yet unarguable,
asymmetry of that examplethat some of the biggest winners merely match
the market and some of the biggest losers are left in the dusthelps
to explain why, after all those costs, there are so few winning needles in
To make matters worse, unlike the funds themselves, most fund shareholders incur yet another costa fifth deduction
from returnsand it is large indeed: the taxes paid to the Federal Government
and to state and local governments on fund dividends and distributions. The
heavy turnover of fund portfolios results in the realization of both long-term
capital gains, now taxable at a maximum of 20%, and short-term capital gains,
taxable at the full income tax rate of up to 40%. For funds held directly
in taxable accounts by investorsthe majority of fund investorstaxes
reduced fund returns by 2.7 percentage points annually during the period,
roughly doubling the costs of fund ownership
that I showed you earlier. Fund portfolio managers
by and large ignore the tax consequences of their decisions. But fund investors cannot afford to ignore taxes: You must pay them. With this extra reduction in the returns
published by the funds, the average equity fund delivered a net annual return,
after costs and taxes, of 11.2% to investors during the last 15 years, just
two-thirds of the pretax market return of 16.9%. The odds of finding the needle
in the haystack that represents the winning fund, then, are actually worsefar worsethan I've indicated.
**NOTE: Like the 30-year analysis, the 15-year data includes only the
384 survivors of the period; 70 of the 454 funds that began the period failed
Invest in the Haystack
If finding a needle in the fund haystack is so difficult, what sensible
course of action is available to fund shareholders? The answer is as straightforward
as it is simple: Stop trying to find the needle. Invest
in the haystack. Own the entire U.S. stock market. Today, that
is as easily said as done.
I'm speaking, of course, of the all-market index
fund. A number of these funds are available today, targeted to
the Wilshire 5000 Equity Index of all publicly held stocks in the U.S. (There
are actually some 8000 such stocks, but these funds basically own the largest
2000 stocks, which account for about 98% of the $14 trillion market capitalization
of the index.) Visualize 75% of the assets of such a fund as being invested
in the 500 large-cap stocks that constitute the Standard & Poor's 500
Stock Index, and 25% invested in the mid- and small-cap stocks that constitute
the remainder of the market. A fund that tracks the 5000 Index truly is the U.S. stock market. The all-market index fund
represents complete diversification, the ultimate response to Cervantes' warning: "Do not venture all your eggs in one basket." It is
the haystack we ought to have been looking for all along rather than seeking
out those impossibly few needles hidden deep within it.
Annual Investment Returns, 19841999
Average mutual fund
5000 Index Fund
Sales commission, 6% (annual impact)
Investor return (after tax)
Reduction in equity return
Source: Morningstar, Vanguard Research.
Of course, the all-market fund would incur costs and taxes, so let's
see how much of the return of the market itself it can capture. We'll compare
its costs with those of the actively managed funds I've just described:
To make a long story short, the stock market's annual return averaged
16.9% during the past 15 years. The average fund, net of its costs and taxes,
earned an annual return of just 11.2%. A no-load, low-turnover, low-cost,
all-market index fund, after its estimated
costs and taxes, would have earned a return of 15.8%a truly staggering
enhancement of 4.6 percentage points per year.
- First, no sales commissions. Most all-market funds are available
on a no-load basis.
- Second, there is no opportunity cost. The fund is always 100%
invested in stocks.
- Third, no (or only minimal) transaction costs, since stocks
are bought and held, essentially forever.
- Fourth, low expenses. No advisory fee need be paid, since
an investment manager is unnecessary. Operating expenses of 0.2% or less have
proven to be feasible.
- Fifth, low taxes, estimated at 0.9% over the past 15 years,
which consists primarily of taxes on net dividend income and, given the funds
nominal turnover, on the minimal realized capital gains that result from corporate
acquisition and mergers.
Source: Morningstar, Vanguard Research.
This difference, compounded, has a staggering impact on capital accumulation.
Assuming an initial investment of $10,000 in 1984, the value of the average
equity fund in late 1999, after costs and taxes, was $49,000. The final value
of the same investment in the all-market index fund would have been $90,000.
Nearly twice as much capital accumulated. Therefore, twice as much retirement
income and a more comfortable life. It would have been nice if the average
fund had merely matched the market. And garnering the market's return shouldn't
have been too much to ask.
Follow the Money
Now let's follow the money. In the active fund, the sales commission
consumed 6% of your capital. Opportunity cost ate up 7%; transaction costs
8%; and management costs 12%. Taxeslargely unnecessaryconfiscated
20%. All told, 53% of the market's return was consumed by our financial market
and tax system, leaving but 47% for the investorwho, much more than
incidentally, put up 100% of the capital and assumed 100% of the risk. It
doesn't seem fair
and it isn't. And there is
a better way. In an all-market index fund, the financial system consumed just
2%, and taxes 11% of your capital, leaving 87% for the investornearly
twice as much as the 47% left by the average equity mutual fund.
Simply by cutting excessive equity fund costs to the bare-bones level,
index fund investors (a) virtually assure themselves that the fund they select
will endure, surviving the vagaries of time
that have carried so many funds to an early grave; (b) substantially eliminate
the huge risk of selecting a losing fund; (c) relinquish only the tiny opportunity
of selecting a winning fund; and (d) assure themselves of nearly 100% of the
market's annual return. Given this balance of risk and return, it's hard to
justify the search for a hard-to-find needle when, right before our very eyes,
the huge haystack lies in full view.
What's to be Done?
I imagine that most of you now own neither an all-market index fund
nor its near-equivalent cousin, an S&P 500 index fund. (Their long-term returns have been nearly identical.) But
it seems to me quite clear that most mutual fund investorsand nearly
all taxable fund investorsshould cease
and desist from their efforts to find the needle in the haystack. Why bother
seeking to select future fund winners when the odds against success are so
awesome and the consequences of failure so grave? Sure, it may take a leap
of faith to give up the traditional search for the needle in favor of an investment
in the haystack. But, as Cervantes warned us, "Faint
heart ne'er won fair lady."
I quickly add even those with stout hearts must look carefully before
they leap. The leap ought to be easy for taxable
equity fund owners who want to use the index fund as a repository for new
money; and those who own equity funds which they can sell and realize little
or no capital gains. (Given some combination of poor fund performance and
large taxable capital gains already realized and distributed, a misguided
fund strategy the penalty for which their shareholders have already paid;
there are many such funds.)
Stout-hearted investors who hold their fund shares in tax-deferred thrift
plans and IRAs should also consider this great leap forward. While the clear tax advantage of index funds is of no special value
to investors in tax-deferred programs, the other advantages of index investing
remain; if they are less compelling, they
are quite compelling enough on their own. For taxable investors who hold fund
shares with substantial unrealized capital gains, however, a faint heart is
an asset. Look before you leap. If your fund holding has a current value of
$10,000 and a cost basis of $5,000, its liquidation would cost you $1,000
in taxes; fully 10% of your assets going directly to Uncle Sam. It would clearly
take some years for the cost and tax advantages of index funds to compensate
you for that loss.
But all investors should recognize
the reality that a well-administered, no-load, low-cost, low-turnover, all-market
index fund is the most sensible way to give up the search for the needle and
own the haystack. In today's perhaps overly optimistic and highly volatile
stock market, however, a second question quickly follows: Is it a good idea
to invest in stocks today? Put another way, is today a wise time to own the
Owning the Haystack Today
Let me appraise the current level of the stock and bond markets by contrasting
today's fundamentals with those that prevailed when I last spoke to you in
September 1988. As for stocks, the Standard & Poor's Index was then at
270, a price that was equal to 12 times its earnings. The yield on the index
was 3.5%, and its earnings were to grow at 7.1% annually (from $23 per share
in 1988 to $48 in 1999). Thus, the fundamental return on the indexthe
portion of its annual return determined by earnings and dividendstotaled
10.6%, a measure that I call its investment
return. Since 1988, its price has risen from 12 times earnings to 29 times,
a change that measures what I call its speculative
return. This increase in the price-earnings ratiothe change from post-1987
pessimism to pre-2000 optimismhas alone tacked an additional 8.3 percentage
points per year onto the investment return, bringing the market's total rate
of annual return to 18.9% during the period. (To illustrate the profound impact
of this speculative return, had the price-earnings ratio merely remained at
12 times, the S&P Index today would be valued at 580, rather than at 1400an
820 point difference. That is, the speculative return has accounted for nearly
75% of the 1130 point increase in the level of the Index.)
Components of Stock Market Return
Initial dividend yield
Initial P/E ratio
Final P/E ratio
Source: Professor Jeremy Siegel, University of Pennsylvania; Vanguard
What might be a realistic expectation for the coming decade? We begin
with today's 1.2% yield; then let's assume a solid earnings growth of 8% a
year, even higher than the 7.1% growth since 1988. (Future earnings growth
could be higher, or lower; in a heavy recession, earnings could even decline.)
That's a 9.2% return, before we factor in
the price/earnings multiple, which is at an all-time peak today. Let's assume
it might ease back to 20 times. (It could remain unchanged; it could even
rise. The long-term norm has been 15.5 times.) That change would knock 3.7
percentage points off the market's return, bringing it to 5.5%even less than the plus-7% return available on high-grade
bonds today. (I know that stocks have rarely provided lower returns than bonds
over a decade; but I remind you that the stock market is not an actuarial
table.) After all that we investors have been given in the fabulous bull market,
it would be hard to feel crestfallen if such an economic return is all that
the stock market gives us. However, if the economics of the fund industry
remains intact, fund costs of 2.5% per year would cut the return of mutual
fund investors to a measly 3.0%, a 45% slash in the return of the stock marketand
before taxes at thatthat would make future fund performance hard to
I've been around too long to describe that baneful forecast as a prediction. None of us is wise enough to be confident
about the level of future market returns. But it is
a projection of what the stock market will provide under a set of expectations that are far
from irrational. The point is that market returns are determined by both investment factorsthe fundamentals of the initial
dividend yield on stocks plus the rate at which their earnings growand
by speculative factorsthe change in
the price that investors will pay for each $1 of corporate earnings. If you
disagree with my numbers, simply determine your own realistic expectations
for earnings growth and for the final price-earnings ratio, and arrive at
your own projection. But never forget that, while the parameters of the investment element of returns are set by the laws of
economics, the parameters of the speculative
element are bounded only by the whims of our emotions.
Bogle and Buffett Agree
But to What Avail?
For those who believe in Cervantes' words that "There
are no limits but the sky," my projections will seem low. But at
least recognize that I'm in good company. No less an investment icon than
Warren Buffett, using an analysis similar in many respects to my own, recently
cautioned that "investors in stocks these days are expecting far too much
The fact is that (while) markets behave in ways that are not linked
to value, sooner or later value counts." He sets "some reasonable expectations
GDP (the U.S. gross domestic product, a measure of how much the U.S.
economy produces) grows at an average of 5% per year
(remain steady or rise)
the importance of dividends to total return
is way down"
and comes up with a future return on stocks of 7% per
year. Mr. Buffett then reduces this return by one percentage pointan
estimate "on the low side, of the frictional costs investors bear, which includes
[just as I did earlier] a raft of expenses for the holders of equity funds,"
and concludes that "the most probable return would be 6%," soberly adding,
"If it's wrong, I believe that the percentage is just as likely to be less
as more." CAUTION: The fact that Buffett and Bogle agree is hardly proof positive
that we know the answers. But perhaps our long experience, seasoned with some
wisdom about realistic expectations for the stock market, may be worth factoring
into your own thought process.
Let me turn now briefly to the bond market. (By the way, I happen to
believe that the advantages of owning the haystack represented by a total bond market index fund vastly outweigh the long-odds
against finding the needle represented by a winning bond fund. The costs of
owning mostbut not quite allbond funds is, well, unconscionable.)
When I last spoke with you eleven years ago, the interest rate on a 10-year
U.S. Treasury bond was 8%, indicating, net of the then 4-3/4% inflation
rate, a real return of 3-1/4%. Today, the yield on a comparable bond is 6%,
or, net of our present inflation rate of about 2%, a real return of 4%. Bonds
were pretty good investmentsthough not as good as stockswhen
I spoke to you 11 years ago; they would appear to be even better investments
Why? Because the relationship between potential stock returns and potential
bond returns has changed substantially since I talked to you in 1988. Then,
the earnings yield on stocks (the inverse of the price-earnings ratio of 12
times) was about 8.4%, slightly more than 100% of the 8% yield of the 10-year
Treasury. Today, the earnings yield on stocks is 3.4%, only 55% of the current
6% Treasury bond yield. This is essentially the relationship that has Federal
Reserve Board Chairman Alan Greenspan worried about the stock marketthough
he has been wrong so far. But, given that stocks carry higher risk than bonds,
this disparity suggests that today seems more a time for caution than for
In my 1988 speech to you, at a time of pessimism, I called your attention
to "the great paradox of the stock market: When stock prices are high [as
they are now], everyone wants to jump on the bandwagon; when stocks are on
the bargain counter [as they were then], it seems difficult to give them away."
Just as I urged you then not to get carried away with pessimism then, so I
urge you now not to get carried away with optimism. The best strategy is to
hold a sound balance of stocks and bonds, a balance that fits your own situation,
the better to "stay the course" no matter what transpires in our ever uncertain
and unpredictable financial markets. Cervantes, once again, had it right: "Forewarned is forearmed."
Return to Speeches in the Bogle Research Center.