Preface to the 10th Anniversary Edition

What a difference a decade can make! And in the first decade of the third millennium—the decade that followed the 1999 publication of the original edition of Common Sense on Mutual Funds—the difference was extraordinary. During the two preceding decades, the U.S. stock market had experienced the highest returns—averaging 17 percent per year—in its two-century history. During the past decade, with major bear markets in 2000-2002 and 2007-2009, stock returns turned negative on balance—minus 1.5 percent per year, one of the two lowest returns recorded for any decade during that two-century span.

Similarly, our economy moved from an era of prosperity that was long and strong to a new era of unknown length, beginning with the sharp recession of 2008-2009—now seemingly coming to a close—followed by a sober recovery in which the “new normal” of real (inflation-adjusted) economic growth will likely look more like 2 percent per year than the “old normal” of 3 percent that characterized our economy over the preceding century.

Those are just a few examples of how our world has changed. Globalization is now taken for granted. War—indeed, wars—have followed peace. Political change has been rife, as Democratic leadership has superseded Republican leadership in our federal government. Borrowing has soared to unprecedented and unsustainable levels. But while our citizens strive to reduce their debt levels, the federal debt is virtually exploding upward, with few signs of diminishment on the horizon.

To one degree or another, all of these recent changes have impacted the mutual fund industry. The returns earned by equity funds have, on average, paralleled those of the stock market, although inevitably falling short. But the stock market momentum of the 1990s carried well into the twenty-first century, and mutual fund assets, having grown from $1 trillion to $5 trillion during that decade, grew to more than $12 trillion by the autumn of 2007, only to tumble to $10 trillion in the aftermath of the stock market crash. Nonetheless, mutual funds continued to attract shareholders; the 50-million-person army of fund investors a decade ago is now 92 million strong.

Times have changed, yes. And the fund industry has become an even more important factor in our nation’s financial, retirement, and economic systems. So it is more imperative than ever that it operates, using the words of the Investment Company Act of 1940, “in the national public interest and the interest of investors.”

With the passage of a decade, 2009 seemed a natural time not only to bring out this updated edition of Common Sense on Mutual Funds, but to evaluate its message. In doing so, I have not altered a single word of the original edition, but have chosen instead to update its voluminous data, and to comment on significant developments that have occurred since then—a retrospective, if you will. The comments are interspersed within each chapter, highlighted in red for ease of identification. I’ve tried my best to be candid in describing occasions when experience confirmed my insights of a decade ago, and when experience failed to do so—in essence, where I was right, and where I was wrong.

I’m delighted to report that my first goal, “to help readers become more successful investors . . . [by] developing a sound investment program through mutual funds” has been confirmed. The principles that I set out in the 1999 edition remain intact—and then some. Yes, intelligent asset allocation—the appropriate balance of your portfolio between stocks and bonds—is key to success. Yes, simplicity rules. Yes, the stock market ultimately reflects the performance of the real economy and of corporate business, and of earnings growth and dividend yields. Yes, the costs of investing matter. (So do taxes.) Yes, passively managed low-cost stock and bond index funds continue to outperform their actively managed peers.

And yes, the returns earned in various investment sectors (including U.S. and international markets) still revert to the mean of the market or below. Yes, returns of individual funds also continue to revert to the market mean, as yesterday’s high-performing funds become tomorrow’s laggards. These simple principles—which I later came to describe as based on “the relentless rules of humble arithmetic”—had to hold. And so they did. After all, “the fundamental things apply as time goes by.”

Alas, my second goal, “to chart a course for change in the mutual fund industry,” failed to materialize. Despite my zeal for such reform—and the powerful evidence that demands it—things have gotten worse. The good side of technology—speed, efficiency, information—has played second fiddle to the bad side—enabling the creation of financial instruments of incredible complexity and risk, for example, and encouraging investors to treat funds as if they were stocks and trade them with alacrity. The dominance of marketing over management remains, as does the triumph of salesmanship over stewardship. Fund directors continue to forget that their job is to serve as fiduciaries for fund investors, and the industry’s governance structure remains stacked against fund investors and in favor of fund managers. So I humbly concede that my hope that “time and reason” (using Thomas Paine’s formulation) would combine to force reform in the fund industry remains unfulfilled.

In sum, while my investment principles have indeed become “sufficiently fashionable to procure them general favor” (again using Paine’s words)—at least among intelligent investors, responsible advisers, and informed academics—my crusade for industry reform has clearly failed to do so. But please believe me when I say that time and reason continue to remain on my side, more than ever in this post-bubble environment, which will inevitably reshape investment thinking over the decades to come.

As my dear friend the late Peter Bernstein perceptively wrote in his Foreword to the 1999 edition, “what happens to the wealth of individual investors cannot be separated from the structure of the industry that manages those assets.” That structure has proved to be deeply flawed, and has subtracted wealth from far too many investors who place their trust in mutual funds. While building the fund industry anew is obviously essential, widespread industry vested interests will make reform a hard conflict to win. So I console myself with Thomas Paine’s words, cited at the close of the preface to the previous edition: “the harder the conflict, the more glorious the triumph.”

JOHN C. BOGLE

Valley Forge, Pennsylvania

October 2009