Scott Cooley: I did want to ask one broader question. I know you have a way you think about equity valuations and prospective returns and although you always preach the course, you try to set, I think, realistic expectations for people. So, can you talk a little bit about current valuations and what people should expect?
John Bogle: Sure. Let me say – and I've got a couple of papers on it. If anybody wants to look, in the most recent, I guess, last year's financial, The Journal of Portfolio Management on my "system for establishing reasonable expectations for equity and bond fund returns," I'll take the easy one first, bond fund. Today's yield on a bond fund is a 91% probability of producing the same yield over the next 10 years. So, the yield is everything in the bond fund. That one simple step. So, you really know what you're going to get in the 10 years in the bond fund.
On a stock fund, it's more complicated. And I divide that into two elements; one is investment return and the other is called speculative return. Investment return is what corporations do and that is the dividend yield that they provide and the subsequent earnings growth that they provide. Speculative return is the amount that is added to that total by changes in the price to earnings multiple.
So, if a price to earnings multiple goes from 10 to 20, as it did in the 90s, that's a double, a 100% increase in the P/E. That's 7% a year, the return in the 90s was added to. And so – I'm sorry, that was the 80s. In the 90s, it went from 20 to almost 40, so you got 7% speculative return for two consecutive decades.
That is not going to happen again. So, today, if you want to look at it through those glasses and establish not predictions but reasonable expectations, you're talking about a 2% dividend yield, maybe earnings growth of 5%, it could be 6%, let's use 5%. That's a 7% investment return. And with the P/E running around 20, if it goes back to 15, kind of its norm, that's a 25%, 30% drop, that's 2% off that return. So, you might be looking at a 4% or 5% investment return – total return on stocks. And combined with maybe a 3% return on bonds, you're talking about maybe a 4% return for a balanced portfolio.
That is not a great return unless you want to look at it in real terms and that is, take out the inflation rate because all those great returns we've had in the past during my career in this business have been much higher but the inflation rate has been about 4%, maybe even 5%. So, you take that out and today's returns look pretty normal compared to the future if the future here holds 1% inflation.
So, there would low returns on a nominal basis, but probably normal returns on an absolute basis. It's an important distinction. But the fact is that lower returns are almost inevitably coming over the decade ahead and beyond and the only way to correct that, I'm sorry to tell you, is a great big market decline and if the market goes down 50%, the 2% yield will go to 4%, kind of the long-term norm. So, from then on it will good and smooth sailing, but that won't be very pleasant to go through.
So, my message to investors is ride out the storms, stay the course and don't change your program all the time. Don't move a lot of money around. A lot of activity is your enemy as Warren Buffett will tell you or anybody else and just stick to a simple plan, think about asset allocation being your most important choice, how much in stocks and how much in bonds, centering on around 60:40, 65:35 and more in stocks when you're younger, less in stocks when you're older.
I think it's still valid, although not precise and I guess I'd add not to get into too much detail, but in the U.S. you would certainly want to take into account social security or any other government benefits you have in other countries around the world or firm pension benefits that you have coming. Take it all as a package and try and allocate around that.
