One of the questions I get asked the most often is, “What should I invest in?” While the right answer depends on a host of factors including your risk tolerance, financial goals, and more, I’ve slowly converged toward one asset class in particular—stocks/equities. I’ve always been a fan of investing in stocks (via index funds/ETFs) and I’m only becoming more convinced of this over time.
But my reasoning for why I prefer stocks over most other risk assets has changed. Historically, if you had asked me why I liked stocks it was because they were a low-hassle way to get exposure to some of the best businesses around the world. For very little effort on your part, you can be a partial owner of a large number of global companies that help you build wealth while you sleep. What’s not to like?
While this logic still holds today, my reasoning for liking stocks over other asset classes has evolved. The issue has nothing to do with what stocks get you, but what they don’t get you. What I’m talking about is high fees and predatory investment practices. Unlike other asset classes where high fees and lack of transparency are the norm, this is far less common when it comes to buying stocks.
And we have one person we should thank for this development—Jack Bogle. Jack, who was the founder of Vanguard, did more to reduce fees in the investment industry than anyone else. According to Eric Balchunas in The Bogle Effect, retail investors have saved over $1 trillion in total because of Bogle’s efforts. Not only did Bogle reduce fees for investors at Vanguard, but he inadvertently brought down fees for the rest of the investment management industry as well. This is why we all have access to cheap, easy diversification via stock index funds/ETFs today.
To give an idea of how much value Bogle saved investors, consider this chart (from Eric Balchunas) that illustrates Vanguard’s market share of industry assets and industry revenue over time:
How many companies can you name that consistently increased their market share for over three decades while not increasing their share of industry revenue? Outside of Vanguard, I can’t think of any. This is “The Bogle Effect” (as Balchunas calls it) at work. By lowering fees, Vanguard was able to capture an increasing share of the market without extracting an increasing share of the fees from its customers. As a result, the rest of the investment industry had to follow suit.
Unfortunately, there’s never been a Jack Bogle for real estate or private equity or many other asset classes. As a result, the fees to access those asset classes have remained elevated relative to stocks. Though Bogle’s influence has likely led to some fee compression across all assets, the fee reductions in private markets are nowhere near as large as the ones we’ve seen in public markets over the last half century.
This is why I believe stocks have an edge over most other asset classes today. Because many of the things that were once prevalent with stock investing (and are still prevalent among other asset classes today) are no longer an issue. When investing in stocks today, you can get the market return without paying a high management fee, a hefty sales load, or other phantom costs. As Jack Bogle once said, “In investing, you get what you don’t pay for.”
Sadly, there is still a lot you do pay for when investing in private equity, farmland, and many other asset classes. While these asset classes may provide benefits that make these additional fees worth it (e.g. diversification, higher returns, etc.), there are no guarantees. You can theorize about the future returns of different asset classes all you want, but the only thing you know with certainty are the fees you will pay along the way. Therefore, by avoiding these higher fees, retail investors should earn a higher return in stocks, all else equal.
Of course, some may argue that all else isn’t equal. Some may also argue that the lower fees associated with investing in stocks have already been “priced in.” After all, as fees go down wouldn’t we expect stock prices to be bid up accordingly? I’ve written on this exact topic before when discussing why higher stock valuations today make sense.
But, how will we know when all the low-fee juice has been squeezed out of stocks? We won’t exactly, but I think we would see some sort of underperformance by stocks relative to most other asset classes. Fortunately, such underperformance has yet to materialize.
Of course, underperformance isn’t the only thing you have to worry about. There’s the higher volatility as well. As I’ve stated before, stocks (as a whole) tend to decline by:
- 10% every other year
- 30% every 4-5 years
- 50%+ once a generation
This is why owning them can be such a challenge. In defense of stocks though, some of this additional volatility is an artifact of higher liquidity and better price discovery. After all, you can’t look up the price of your home minute-by-minute from 9:30AM to 4PM Eastern Time 5 days a week, but you can check the price of your stocks. By measuring prices less often, private assets may seem less volatile than they actually are.
Regardless of actual or perceived volatility, stocks should comprise the majority of your risk assets. Not only are they easy to invest in, but they are the asset class where you get to keep most of the underlying return stream. Lower fees and reduced transaction costs over the past few decades have made this possible.
Don’t just take my word for it though. Barton Biggs, the author of Wealth, War, & Wisdom, came to the same conclusion about stocks after analyzing which asset class was the best to own in any economic environment. As he stated:
In my considered but not necessarily correct opinion, a family or individual should have 75% of its wealth in equity investments. A century of history validates equity as the principal, but not the only, place to be.
Biggs’ book was published in 2008 and he didn’t even consider fees or transaction costs in his argument. Well, I did and that’s why I’ve been hesitant to recommend alternatives for retail investors. Despite their touted diversification benefits, I am worried about future fees and liquidity. This is why 70% of my investable assets are in stocks and I have no plans to change that.
Whether you choose to follow suit is up to you. Happy investing and thank you for reading!
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This is post 403. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data