Bogle on Mutual Funds: New Perspectives for the Intelligent Investor.

As the title suggests, John Bogle has written a book that he hopes will do for mutual fund investing what Benjamin Graham's classic The Intelligent Investor [1] did for security analysis. Bogle, the founder and chairman of the Vanguard Group of Investment Companies, has written a book that is quite unique. One would expect Bogle to write a book that would outline the basic tenets of mutual fund investing and to use the opportunity to plug the Vanguard family of mutual funds. Fortunately, this is not the case. Except for the preface, no mention of the Vanguard Group or any other mutual fund group is made in the book. The majority of the book is an academically oriented study that would be expected from a Roger Ibbotson rather than from the chairman of Vanguard. From a stylistic point, this book may remind readers of Burton Malkiel's widely regarded A Random Walk Down Wall Street [2], with its honest look at the mutual fund industry. However, like A Random Walk Down Wall Street, this book requires some background in financial theory, which makes it ideally suited as a supplemental reading in investments and portfolio management courses.

The book is filled with numerous graphs and tables that show the historical returns for the S&P 500, long-term bonds, and cash reserves beginning as early as 1871. In addition, the book also references numerous important topics usually omitted by other popular investment books including duration, portfolio betas and alphas, "exmark" (which stands for explained by the market, actually the [R.sup.2] from the market model regression), stock market volatility, use of derivatives, survivorship bias, regression towards the mean, portfolio turnover and market efficiency.

Specifically, the book is divided into four parts. The first three parts of the book use historical data to show the rates of return and risk for different securities and different types of mutual funds. Only in the final part of the book does Bogle provide general guidelines for mutual fund investing. However, unlike other popular investment books, Bogle points out the logic that drives his rules of thumb. Bogle is also quick to note that investors should consider modifications to his guidelines based on their own personal situations.

The first part discusses the building blocks of investing. Chapters 1 and 2 cover the returns and risks of investing. Chapter 1 uses historical returns for common stocks, long-term bonds and cash reserves to illustrate the magic of compounding. Chapter 1 also introduces several valuation methods for common stocks and explains the different types of yields reported by bond funds. In addition, Bogle explains the importance of duration and reinvestment rates to bondholders.

Chapter 2 covers the risks of investing. Bogle begins by pointing out the risk of inflation and linking nominal returns and real returns to the rate of inflation. Again, detailed historical data is used to illustrate the point. Bogle also breaks up the total return risk of an asset into principal risk and income risk and aptly points out that an investor can protect himself from one, but not both types of risk.

Chapter 3, "Mutual Funds: Principles, Practicalities, Performance," covers the growth of the mutual fund industry and some of the reasons for mutual fund investing such as diversification, liquidity and professional management. Also included in this chapter is a brief introduction to mutual fund performance and the importance of selecting an appropriate benchmark for comparison.

Part II covers the mutual fund selection process. Chapters 4 to 7 cover how to select different types of mutual funds. Bogle uses past rankings of funds to illustrate the difficulty in identifying common stock funds with superior performance by showing how returns tend to regress towards the mean for all mutual funds. Because of the difficulty in identifying common stock funds with superior performance, Bogle points out the importance of evaluating the costs of owning the fund and the drain on returns from owning high cost funds. This point is especially well made in his discussion of bond and money market fund selection. Because the securities selected by bond and money market fund managers tend to be similar, management will be unable to significantly improve returns through security selection. The one exception is through careful control of costs.

Chapter 8 covers where to get mutual fund information, including how to read a prospectus and annual report and how to use Morning Star Mutual Funds. Especially interesting is the time devoted to using information in the annual report and prospectus to determine the costs the fund incurs, including the portfolio turnover rate, all of which impact the returns to shareholders.

Part III covers three key issues: index funds, mutual fund costs, and taxes and mutual funds. Academics will especially enjoy chapter 10 on index funds. This chapter uses the efficient market hypothesis to argue for the use of index funds. Once again, cost becomes the deciding factor. Because historically the "market" beats two thirds of the common stock mutual funds each year, Bogle argues that low cost index funds may well provide the intelligent investor with a sensible alternative to traditional mutual fund investing. Chapter 10 covers in detail the different costs that funds assess, and what they mean to shareholders. Chapter 11 covers some of the tax consequences faced by mutual fund investors.

The final part of the book, provides basic advice for mutual fund investors. Chapters 12 and 13 cover asset allocation strategies for individuals in different phases of their investment cycle. Chapter 14 provides an interesting challenge to mutual fund shareholders encouraging them to demand full disclosure in fund reporting and low cost quality service. Finally, the Epilogue reviews the "Twelve Pillars of Wisdom", which review the basic tenets of mutual fund investing outlined throughout the book.

In sum, Bogle on Mutual Funds is a carefully written and researched analysis of the mutual fund industry. This book can serve as an excellent supplemental text for courses in investments, and portfolio management by motivating topics commonly covered in these courses and by raising issues usually ignored in these courses.

Ronald L. Moy St. John's University

References

1. Graham, Benjamin. The Intelligent Investor. Fifth Edition. New York: Harper & Row, 1973.

2. Malkiel, Button G. A Random Walk Down Wall Street. New York: Norton, 1990.