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Columns: Boomer Bucks
Barbara Mlotek Whelehan Expert: Barbara Mlotek Whelehan
Boomer Bucks
You can save thousands of dollars cutting out the middle man
Boomer Bucks

There's no mystery in building portfolio
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But don't pay attention to that last bit and go right ahead and splurge on his latest book. It's less than $20 and well worth the investment.

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In it he presents so many compelling arguments that you will likely be converted to his way of thinking. So-called "Bogleheads," who refer to their leader as "St. Jack," already know his mission: Abandon the search for the needle in the haystack -- the next best-performing fund -- and instead buy the haystack, or the entire market itself. Buy it as cheaply as possible through low-cost index funds.

A compelling example
Bogle looks at the 25-year period from 1980 to 2005, when the Standard & Poor's 500 Index gained 12.5 percent on average per year. The average mutual fund gained 10 percent -- a 2.5 percent difference in performance attributable mainly to expenses. "Never forget: Market return, minus cost, equals investor return," Bogle says.

A $10,000 initial investment over that time frame in an index fund with expenses of 0.2 percent would have grown to $170,800. The average equity fund's value at the end of the period was $98,200.

Which pile of money would you rather have?

"What you see here -- and please don't ever forget it! -- is that over the long term, the miracle of compounding returns is overwhelmed by the tyranny of compounding costs," Bogle says of actively managed equity funds.

Bogle figures investors actually didn't earn 10 percent during that time frame but rather 7.3 percent (and index investors only earned 10.8 percent) because of their tendency to trade in and out of funds. They often sabotage themselves by getting into a hot fund at precisely the wrong time -- just before it freefalls.

The beauty of the indexing strategy, says Bogle, is that after the initial setup no further action is required. In fact, too much investment activity results in transaction costs that further erode returns.

In Chapter 10, Bogle cites several studies (including the one mentioned above) that show that advisers aren't particularly adept at selecting funds which beat the market. He says he has a hard time imagining they add much value -- unless they select low-cost funds with low turnover (which have lower transaction costs and are more tax-efficient). "If they put those two strategies together and emphasize low-cost index funds -- as so many advisers do -- so much the better for their clients," says Bogle.

But most advisers are reluctant to follow an indexing strategy because -- hey -- where's the added value there? Why should individuals hire an adviser to buy cheap index funds (and then pay the adviser a percentage point a year from portfolio assets for the privilege) if they can do this for themselves?

Next: "... to provide some stability to your portfolio ..."
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