What’s the difference between speculating and investing? For millions of people, it’s the real-world difference between retiring on time or working years longer than they had expected.

J.P. Morgan recently published data that shows a diversified portfolio over two decades returning a solid 8% annually to the investor. Yet the typical small investor in that same time frame actually experienced a dismal 2.5% return.

That’s more than triple the difference! So what’s going on here?

First off, small investors overpay dramatically for the advice they get. Then, unfortunately, they take that flawed advice and concentrate their investments into a narrow set of “bets” that fail to deliver — over and over. Things end very badly once you pile up two full decades of below-inflation returns.

That’s a major reason Vanguard now has an estimated $3 trillion in assets under management. Vanguard Founder John Bogle’s essential insight was that people didn’t need or really want “outperformance” that increasingly few financial advisors could deliver. What they need is results.

The two biggest drains on the long-term performance of a retirement portfolio are heavy stock-broker commissions and fees and losses from emotional trades that can result when an investment goes a direction we don’t expect.

Low-cost portfolio investing, instead, is about finding the golden mean that results in a predictable, repeatable return. It also happens to produce a much higher sustainable return.

John Rekenthaler, the vice president of research at Morningstar, just wrote an interesting analysis of Bogle and the key insight that drives success at Vanguard. Bogle, Rekenthaler argues, figured out that what matters most to investment success is predictability, and that comes in two flavors: absolute and relative.

People focus a lot on absolute predictability, ideas like the value of a dollar. We love the idea of understanding what a dollar means to us. It’s physical, tangible, we get them for performing work. We teach our kids to respect it.

Relative predictability is a different beast. What it means, Bogle told Rekenthaler, is that an investment behaves as expected relative to the wide variety of alternatives you might have chosen.

Cash is an investment. Stocks are an investment. Bonds, commodities, real estate, all investments. The really big risk question is, does your particular method of investing in these categories behave as expected? Is it relatively predictable?


There is a fine difference here, one a lot of retail investors miss. I’ll give you an example: If you buy 10 stocks you have selected after much thought, there is a chance that your small slice of the equities market will outperform the entire stock market index, say, the S&P 500.

There is also a chance that you will underperform the index. How far above or below your expectations is a matter of events and personalities and economic factors far, far beyond your ability to observe, much less control.

But, you’re optimistic. Maybe it will work out great. Now, compare that to just owning the index and holding it over the years.

The events and personalities and outside factors begin to cancel each other out. After fees (and this is important), you are left with the performance of the entire class of investments. Now we’re onto something that’s relatively predictable.

That kind of predictability is found in portfolio-driven index investing. Speculating is a fine pastime if you have the money to  blow, but most people want and need more security in their retirement planning.

It’s perfectly understandable, yet seeking security and predictability also is the superior investment approach by far.

Send this to a friend