When I joined Vanguard in 1982, the firm’s flagship fund was not the renowned 500 Index Fund
but the venerable Wellington Fund
Founded by Walter Morgan just before the great stock-market crash of 1929, Wellington reflects the fundamental principles of successful investing: balance; diversification; discipline; low costs and a long-term orientation.
These principles are a sound foundation for a prudent investment program and also serve as a sensible business strategy that Vanguard has successfully adhered to since its founding. I have been fortunate to learn a considerable amount from my predecessors and colleagues, Vanguard clients, and the investment professionals whom I’ve been associated with during my 40 years in the investment industry. I’ve compiled these lessons in a new book, “More Straight Talk on Investing,” which is well-timed given some of the challenges facing investors today.
I’ll address five current challenges and offer strategies to address them. Some require going on offense, while others necessitate a stout defense.
1. Unrealistic expectations: Since its low point in March 2009, the S&P 500
has produced a total return of 652% (18.1% on an average annualized basis) through March 2021, including an extraordinary 81% rebound from the COVID-19 crash in early 2020. The past dozen years have seen returns well-above the historical average. Indeed, from 1926 through 2020, U.S. stocks provided much more modest average annual returns of 10.3%.
These recent heady returns have prompted unbridled exuberance among some market participants. According to reported Piper Sandler data, total equity volume has doubled from 2019 levels — a considerable increase driven primarily by retail investors. It reminds me of the “trees grow to the sky” mentality of 1999 prior to the bursting of the tech bubble.
What to do now? Play defense. Don’t presume that future returns will be as generous and resist the temptation to “panic buy” on fears of missing the next big upswing. If you have a thoughtful asset allocation based on your personal goals, time horizon, and risk tolerance, stick with it. And if you expect less bountiful returns going forward, consider increasing the amount you put away.
2. Speculation: The dark side of a 12-year bull market is the re-emergence of short-term trading of individual stocks and speculation on everything from cryptocurrencies to non-fungible tokens. Frankly, I have difficulty seeing why one would commit money to something with no underlying intrinsic value and questionable economic purpose. Moreover, heavily promoted zero commissions and video game-like trading applications have only fanned the flames.
Defense is called for here again. Hold broadly diversified mutual funds and exchange-traded funds for the long-term. Use time to your advantage rather than trying to choose the best time to invest.
3. Low interest rates: Persistently low interest rates have led many investors to ask: Where did my income go? Interest rates will eventually rise, but it is anyone’s guess as to when and how much.
The implications of low rates for average investors and, especially, people living off the income generated by their investment portfolio, are profound. Consider that a $100,000 investment in 90-day U.S. T-bills in November 2006 would have produced interest of $1,250 over three months. The same investment today — and for most of the past 10 years — generated income of just $25 — a 98% decline in the productivity from an investment in the world’s safest instrument.
The story is similar for 10-year U.S. Treasury bonds
which have suffered an 80% decline in income over the past 12 years. Equally important: Low rates present significant capital-loss risk for longer maturity bonds (and bond funds) when interest rates do rise.
In the meantime, consider going on the offense and pursuing other means of generating income by: 1) reducing holdings in low-yielding money-market funds and 2) increasing your allocation to high-quality, dividend-paying stocks. At the same time, don’t reach for yield or fall for “too-good-to-be-true” investment pitches offering “high yield without risk.”
4. The threat of higher inflation: For the past three decades, U.S. inflation has been low, leading some investors to discount it as a threat. Yet veteran investors will remember that in the late 1970s inflation reached double-digit levels. For the 1973–1982 period, the annual inflation rate averaged 8.7%. At that rate, a car that cost $20,000 would be priced at $21,740 one year later. Five years later, the price of the same car would be $30,351. Of course, it’s not just big-ticket items that are affected by inflation. Virtually everything you buy costs more — from a gallon of milk to a pair of running shoes.
It’s safe to assume that inflation will be a factor to one degree or another during your investing lifetime. For this reason, it’s vital to consider inflation when you calculate how your investments will grow with time.
Inflation is also an important consideration in portfolio construction. The real returns (i.e., adjusted for inflation) of cash investments have not kept pace with inflation. Bonds are particularly vulnerable, too, because a considerable portion of their return consists of interest payments, which are worth a little less each year in an inflationary period. (At one point in the 1970s, bonds were facetiously known as “certificates of confiscation.”) As such, most long-term investors need to hold a significant stake in stocks, which provide more stable dividends and the potential to increase substantially in value.
5. Social media: Most of us are constantly barraged by market and business news. As you toggle through news and social media feeds on your phone or tablet, you’ll see myriad posts or headlines that might compel you to act.
Ignore the wisdom of influencers and the incessant tweets for they can tempt you to make moves that aren’t in your best interests. The noise on social media is irrelevant to long-term, buy-and-hold investors. You are better off seeking to educate yourself about the markets and investing from reputable news outlets.
The strategies outlined here will not get you rich overnight; I know of no strategies that accomplish that lofty goal. Rather, they offer a game plan for marching steadily down the field to long-term investment success.
Jack Brennan is the former chairman and CEO of Vanguard. He is the author of More Straight Talk on Investing: Lessons for a Lifetime (Wiley, 2021).