From Chapter 8

Research on Safe Withdrawal Rates

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JWR1945
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From Chapter 8

Post by JWR1945 »

From Chapter 8

In Chapter 8 of our featured book, Common Sense on Mutual Funds, John Bogle talks about Global Investing, which he considers folly. He recommends that those who disagree with him allocate no more than 20% to international holdings.

He considers the opportunities within the United States to be more than adequate. He sees no need sufficient for accepting currency risks. He points out that what seems to be a superior return in a foreign market is usually an illusion, nothing more than a change in an exchange rate.

The really interesting part of this chapter, however, is how completely John Bogle discredits the notion of using the efficient frontier. At the efficient frontier, an allocation provides the greatest increase in the overall return relative to risk (as measured by volatility). If you are able to locate the efficient frontier successfully, you are better off reaching a higher level of return by leveraging your investments at that particular allocation than by changing allocations.

John Bogle showed that the efficient frontier was unusable. He showed that it produced extreme changes in allocations based on changes in risk so small as not to be meaningful. He showed that normal changes in the market caused vast changes in the efficient frontier from one decade to the next. Normal changes swamp out any advantage that an optimal allocation is supposed to provide.

John Bogle has more gems in this chapter. One fascinating comparison is that of Japan's market share in equities just before its decline and that of the United States today. At its peak, Japan's stock market share was 43% of world equities while the United States share was 28%. By mid-1998, Japan's share was down to 9% and the US share had increased to 48%. Those dramatic changes took place in less than a decade.

As might be expected, John Bogle sees a potential benefit in having international index funds. Regular international funds have very high expenses, high transaction costs, and poor liquidity. They can easily add up to 4% per year. That presents an exceedingly high barrier for international funds to overcome.

I will add that large amounts of money sent into illiquid emerging markets can create large price swings and huge losses for investors (and huge gains for the locals who know when to sell out).

I think that John Bogle has come up with some compelling bits and pieces, but not necessarily so compelling as to keep one out of foreign markets altogether. I view this as a matter of one's area of competence (as Warren Buffett might say) or as a matter of one's clear-cut area of incompetence (as I might use when referring to myself regarding international investments).

Keep in mind that John Bogle limits his arguments to those appropriate to fund investors. Those who buy individual securities face additional challenges.

Have fun.

John R.
Last edited by JWR1945 on Sun Oct 03, 2004 9:55 am, edited 1 time in total.
bpp
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Post by bpp »

Hi John R.,
John Bogle showed that the efficient frontier was unusable. He showed that it produced extreme changes in allocations based on changes in risk so small as not to be meaningful. He showed that normal changes in the market cased vast changes in the efficient frontier from one decade to the next.
The reply I have seen to this point is that what it really means is that the efficient mix has large error bars on it. That is, the differences among 60/40, 50/50 and 40/60 combos of some pair of assets are not really that significant. That is not to say that there would not be a big difference between 90/10 and 10/90, however.

Also, one decade would be too short a dataset to use anyway.

Bpp
JWR1945
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Post by JWR1945 »

The comparisons were for 50-50% and 80-20% for the S&P500 and EAFE.

Bogle's chart is on page 192. It is Figure 8.1.

Since the comparison is with international stocks, the comparisons must necessarily occur after World War 2. The decades examined were for 1978-1988 and 1988-1998. Each curve presents the ten-year combination of return and volatility for different allocations. Each dot on each curve represents a 10% increment in an allocation. The best allocation is at the extreme left of each curve, where the slope of a line tangent to the total return versus standard deviation curve is vertical. For those who wish to avoid leverage, a good choice of allocations would be up and slightly to the right (but not by much) relative to the best allocation.

Bogle's observations are well known and widely accepted when stated differently. Mean variance optimizers tend to place too much emphasis on recency. They tend to recommend purchasing the latest combination of stocks (and/or other investments) that have been the hottest. That is a well known formula for disaster.

Have fun.

John R.
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ElSupremo
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Post by ElSupremo »

Greetings John :)
I think that John Bogle has come up with some compelling bits and pieces, but not necessarily so compelling as to keep one out of foreign markets altogether.
More than compelling enough for me. ;) One of the best chapters in the book IMHO. (Although I liked them all! :great:)
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peteyperson
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Re: From Chapter 8

Post by peteyperson »

John,

It really depends on what your investing philosophy is. Are you aiming to reduce the volatility of results yearly or get the highest return? Do you want to own a selection of businesses you understand or are you okay owning some outstanding businesses, mostly average businesses and a chunk of truly awful ones (an index fund)? Bogle takes a very fixed approach to investing which colors his opinions on global investing. One shouldn't take his global investing view in abstract as it it closely connected to his index view.

Personally, I would be far happier getting a market matching return over a ten year period by owning a small group of carefully selected businesses. I would prefer that those businesses cover a number of regions and currencies as exchange rates can move around substantially from decade to decade even when taking a long term view. For those investors outside the US, investing is tricky as many businesses including a substantial percentage of the best ones are global businesses located in the US. For those investors in the US, the questions comes back to your priorities of smoothed out returns vs highest possible returns. If you seek the highest possible returns and invest in individual stocks, then one would naturally seek the best businesses globally rather than restricting to a single region. You do of course have the option to only invest at home but restrict yourself to a smaller group of ten exceptional businesses instead of a somewhat larger group of twenty exceptional global businesses instead.

Petey
JWR1945 wrote:From Chapter 8

In Chapter 8 of our featured book, Common Sense on Mutual Funds, John Bogle talks about Global Investing, which he considers folly. He recommends that those who disagree with him allocate no more than 20% to international holdings.

He considers the opportunities within the United States to be more than adequate. He sees no need sufficient for accepting currency risks. He points out that what seems to be a superior return in a foreign market is usually an illusion, nothing more than a change in an exchange rate.

The really interesting part of this chapter, however, is how completely John Bogle discredits the notion of using the efficient frontier. At the efficient frontier, an allocation provides the greatest increase in the overall return relative to risk (as measured by volatility). If you are able to locate the efficient frontier successfully, you are better off reaching a higher level of return by leveraging your investments at that particular allocation than by changing allocations.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

peteyperson
Personally, I would be far happier getting a market matching return over a ten year period by owning a small group of carefully selected businesses.
I share this preference.
I would prefer that those businesses cover a number of regions and currencies as exchange rates can move around substantially from decade to decade even when taking a long term view.
I expect you to do much better than I because of this.

I am acutely aware of how I could blunder when investing internationally. You are in a more difficult position and that forces you to educate yourself. I anticipate that you will receive ample rewards as a result.

Have fun.

John R.
peteyperson
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Post by peteyperson »

Hi John,

Well you actually gave me encouragement in this area. I have found myself increasingly unhappy with what I was reading under the guise of modern portfolio theory and everything is efficient. It ignores obvious evidence to the contrary. Many investors will learn the MPT way and then anchor to that method, unwilling to consider an alternative view. I've tried to leave myself open to new ideas and my ongoing education has reached a level now where I can understand Buffett in a way I never could before. His thinking speaks directly to what I was feeling in my gut, the disquiet with set asset allocation policies in the absence of rational thought.

On the subject of bonds (other thread), I am presently reading a very comprehensive book called " The Bond Book " which covers them from the basics to much detail written by a former bond trader. Whilst I'm still leaving myself open to consideration of them, I'm thinking the reading will be more useful to understand bonds and how they relate to business financing in companies I am interested in.

Petey
JWR1945 wrote:peteyperson
Personally, I would be far happier getting a market matching return over a ten year period by owning a small group of carefully selected businesses.
I share this preference.
I would prefer that those businesses cover a number of regions and currencies as exchange rates can move around substantially from decade to decade even when taking a long term view.
I expect you to do much better than I because of this.

I am acutely aware of how I could blunder when investing internationally. You are in a more difficult position and that forces you to educate yourself. I anticipate that you will receive ample rewards as a result.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

For peteyperson: how about posting a couple of book reviews? If not entire books, perhaps a chapter or two? You are very knowledgeable and I think that we all can profit from what you have to say.

Have fun.

John R.
peteyperson
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Post by peteyperson »

Hi John,

I think perhaps it is better if I spinkle in knowledge as it pertains to discussions and link to the sources as I've been doing. It then is up to the reader to consider it. The arguments which pertain to matters currently under discussion may be pursuasive enough to get readers to consider reading the book, rather than a bland review which might get more easily dismissed. As I've done with yourself in the last couple of days, peeking interest when someone has their eyes open to new ways of thinking about things.

Petey
JWR1945 wrote:For peteyperson: how about posting a couple of book reviews? If not entire books, perhaps a chapter or two? You are very knowledgeable and I think that we all can profit from what you have to say.

Have fun.

John R.
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