What John Bogle Has to Say about ETF in “The Little Book of Common Sense Investing”

I bought Mr. John Bogle’s new book, The Little Book of Common Sense Investing, after reading an article on SmartMoney.com the other day about his comments on ETFs. The book was received early this month, but I didn’t get time to read it until recently.

In his latest writeup, Mr. Bogle uses a chapter to discuss exchange traded fund (ETF), which he describes as “a fund designed to facilitate trading in its shares, dressed in hte guise of the traditional index fund.” In arguing the difference between classic index fund and ETF that tracks an index, Mr Bogle gives us a table

to make the case that

after all the selection challenges, the timing risks, the extra costs, and the added taxes - typical ETF investors have absolutely no idea what relationship their investment return will have to the return earned by the stock market.

However, with some exceptions, Mr. Bogle seems to agree that “all-stock-market ETFs are the only instance in which an ETF can replicate, and possibly even improve on, the five paradigms of the original index fund listed earlier. But only when they are bought and held for the long-term.” On the other hand, for sector ETFs, Mr. Bogle thinks that

whatever returns each sector ETF may earn, the investors in those very ETFs will likely, if not certainly, earn returns that fall well behind them. There is abundant evidence that the most popular sector funds of the day are those that have recently enjoyed the most spectacular recent performance, and that such “after-the-fact” popularity is a recipe for unsuccessful investing.

If ETFs are really as bad as Mr. Bogle can describe, why they are introduced in the first place? Well, the answer is very simple: because “ETFs are clearly a dream come true for entrepreneurs, stock brokers, and fund managers.” But what about investors who poured billions of dollars into ETFs?

Is it too much to ask whether these index fund nouveau are an investor’s dream come true? Do investors really benefit from being able to trade ETFs “all day long, in real time”? Is less diversification better than more diversification? is trend-following a winner’s game, or a loser’s game? Are ETFs truly low-cost when we add brokerage commissions to their expense ratios? Is buy-and-sell (often with great frequency) rally a better strategy than buy-and-hold? If the classic index fund was designed to capitalized on the wisdom of long-term investing, aren’t investors in these index funds nouveau too often engaging in the folly of short-term speculation? Doesn’t you own common sense give you the obvious answers to these questions?

Are you going to invest in ETFs?

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