The Clash of the Cultures: Investment Vs. Speculation

Bogle cements his place as a god amongst men in this investment classic.

John Bogle cements his place in history for transforming how the mutual fund industry conducts business and how it treats its clients. Clash of Cultures serves as an important reminder to investors tempted by short term speculation: frequent trading and speculation is a losing game when compared to a long term investment.

Although the world continues to change, the principles discussed in this book do not. A long-term strategy of buying and holding an index fund will continue to be superior to short term trading for retail investors. Outperforming the indices does not indicate superior skill, rather, it reflects the variable nature of stock market performance. Rampant speculation in the derivative market has only strengthened this argument. If the events of 2008 are any indication, Wall Street will continue to speculate at the expense of investors.

“The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.”

John Bogle

Cognitive Biases Impede Performance of Your Investment

I certainly agree with Bogle that humans display clear cognitive biases in their investments. History has shown that beating the markets without superior information is extremely difficult, yet investors continue to believe they have superior skills and can outperform the market. Each decade, over 50% of hedge funds go out of business, and 80% of hedge funds underperformed the market.

Not to mention that the 20% who beat the market can attribute their performance to short term variance, just as a blackjack player can have the hot hand in the casino. Yet, over the long run, these investors are playing a losing game. Just as the house in Vegas erodes the players expected value, transaction costs erode profits making a zero-sum game a losing game.

Wall Street Needs to Stop Acting Like a Casino

The parallels between Wall Street and casinos cannot be ignored, and its impact is pervasive. In response to the GameStop crisis, Elizabeth Warren (D-MA) claimed “For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price.”

It is hard to ignore the parallels between Bogle’s advice of staying out of the Wall Street casino and the sentiment exuded by Washington. Short-term speculators have certainly made long-term investors pay the price. Indeed, many new investors watched as their speculative investments disappeared before their eyes, just as speculators have throughout history. Bubbles share similar characteristics throughout history, so it is perplexing to see investors fall into the same traps investors before them have made.

You’d think we’d learn by now right? Bogle is certainly right that history repeats itself. With all of our fancy technologies and tools, we still fall prey to the mania of the market. The GameStop (GME) mania seen in the stock market is a clear example of how long-term investing has become overrun out by short term speculation. When Bogle said that “trading in the deriviatives market has reached detrimental levels,” I didn’t think it would be this bad. Who would’ve thought that short interest can exceed the number of outstanding shares of a stock? GameStop made the Dutch Tulip Mania look like childs play.

Bogle was on the right track when he advised caution against fund managers over-hyping the prospects of investing. However, his caution did not go far enough. What Bogle did not foresee was that the media would take the role of the salesman away from fund managers. The mainstream media has increasingly begun to glorify the financial markets, for its prospects of “hitting it big.”

Clash of Cultures specifically advises against this when comparing day trading to state run lotteries. Bogle speaks at length about moving the mutual fund industry towards greater stewardship on behalf of their clients. The media needs to be held to a higher standard of stewardship for its role it plays in the markets. The GameStop trading bubble dominated the front page of every major news source, and it is conceivable that this contributed to the speculation. Robinhood signed up 3 million Americans for a brokerage account in one month.

Stay the Course

For many of you, Bogle’s advice is probably nothing more than a useful reminder. If you have been reading my past articles, you know I have strong opinions on trying to time the markets. Success takes hard work and dedicaton. There’s no quick route to greatness: especially not in the financial markets.

Remember, bulls and bears make money. But pigs, those beasts, they get slaughtered.