The field of play
Some small things make a big difference
In this post I look at two scenarios of investment returns. The first is to compare stocks and bonds in a so-called balanced portfolio. The second is to compare active and passive stock investing. The idea will be to think about compounding in this connection.
To start with the first scenario, let’s take the case of a portfolio invested 60% in stocks and 40% in bonds and compare it with an all-stock portfolio.
We can rely on John Bogle to do the math for us.
John Bogle
Mr. Bogle, who died in 2019, was the founder and former chief executive of the Vanguard Group. He created one of the first index funds whose byword has been driving costs down across the fund industry. The Vanguard Group manages some $10 trillion as this is written. John Bogle wrote several books. His 1999 book Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor was a bestseller and considered a classic within the investment community.
The edge for equities
In 2013, at 83 years of age, John Bogle, in an interview with the Toronto Globe and Mail newspaper, in promotion of his new book, The Clash of Cultures: Investment vs. Speculation, said:
“In the coming decade, if equities do 7 per cent a year – a reasonable enough number – and bonds will be doing less than this because interest rates are so much lower, say 3 per cent a year – and you have 60 per cent in equities and 40 per cent in bonds, that’s 5.5 per cent. Then you take out costs, call it 1 per cent, that’s 4.5 per cent. They never talk about costs – they talk about market return. Which is just stupid to think you can capture the market return [after costs]. Nobody does!”
He allows equities a 4% edge in nominal total return. That is, the return on equities includes dividends and is not adjusted for inflation. He assumes equities will give a return of 7% and bonds a return of 3%. With those assumptions, he figures the mixed portfolio will return 5.5% before fees and costs.
Using low-cost index mutual funds or ETFs, the fees should be a bit lower than this. After fees and costs, the mixed portfolio might return 4.5%. By his assumptions, a pure equity portfolio would produce a return of 6%; that is, a basic return of 7% less 1% fees and costs.
On these assumptions, the all-equity portfolio will earn 1.5% more than the mixed 60/40 portfolio over the long haul or 33% more per annum compounded than the mixed portfolio. Long term calculations of the Equity Risk Premium suggest this approximate edge is baked in to the difference between equities and bonds. You can adjust the numbers for inflation and interest rates but the relationship stays the same.
A satisfactory return
In truth, both 60/40 and all equity returns using S&P 500 index funds like VOO (cap weighted) or RSP (equal weighted) for equities and something like BND, the Vanguard Total Bond Market Index Fund, will provide what Ben Graham describes as ‘satisfactory’ returns over the long haul. But, an edge of even 1.5%, i.e. 33% more per annum compounded, is nothing to sneeze at, as we will see in the next section when we look at the effect of compounding on small differences in returns over many years.
The message I take from Bogle’s numbers is that over the long haul, an all-equity passive equity index fund will outperform a mixed stock/bond passive fund. The only downside to the all-equity approach is increased volatility. Over the long haul, increased volatility is not increased risk and all equities will actually give better protection against inflation.
Active vs passive
In my experience, active investing in common stocks can provide a better return than passive investing. It’s not easy. It requires a businesslike approach. It requires sustained effort. It requires a sound investment process as detailed in this blog. But the higher return makes it worthwhile.
I will offer some calculations based on my own experience. I use myself as a case in point not to boast but to offer a real-life example of the magic of compounding.
I have used the tools found here. Readers might want to explore the Investor.gov website found here:U.S. Securities and Exchange Commission
My first full year of investing was 1973. From 1973 to 2025 the S&P 500 produced a compounded nominal rate of return of 10.85% with dividends reinvested. Index funds were not available in 1973 but all equity mutual funds were. I make some minor assumptions and adjustments below, but they are irrelevant in illustrating how a small increase in returns can make a huge difference due to the magic of compounding.
Let’s look at what would have happened if you had invested $100 at the beginning of 1973 in the S&P 500. We will assume you invested in a minimal fee index fund passively over a period of 52 years. At the end of this period your $100 would have become $21,196.12. I know that seems unreal but it’s true.
Now let’s assume you had invested $100 at the beginning of 1973 in an actively managed equity portfolio and achieved the same compounded return of 13.30% that I got over the period 1973 to 2025. The $100 would have grown to $66,062.55. This is over three time the amount with only an extra 2.45% compounded return over the 52 years. This is the magic of compounding. The return is 22.5% better per annum compounded for active.
The message is clear and simple. Compounding of common stocks over the years can turn $100 into more than $20,000 and an extra couple of percent return can make that figure over $60,000.
Reality check
When you are saving for retirement, you might be contributing to your investment accounts for something like 35 years before retiring. The first dollar saved will have earned an investment return for 35 years, not 52 years. But, in your second year of saving for retirement, the dollars saved in the second year will have earned an investment return for only 34 years when you retire. And so on. The money saved for retirement the year before you retire will only have been invested for one year.
After that, when you are retired and start living off your investments, you are drawing down cash from your investments to live on.
While in theory the first dollar I saved in 1973 for retirement is still working for me, the actual situation is more complex. You also need to factor in the effects of inflation. The $20,000 and $60,000 are nominal. And of course inflation also compounds.
None of this changes the very real magic of compounding and the magic of earning an extra 2.45% over the years.
Conclusion
Almost all investors will know about compounding. But, it’s hard to get through your head what it can really do. So many investors think they have to swing for the fences all the time to achieve good returns. That’s just not true. Just getting on base regularly is the way to win over the long haul. And, in my view, an all equity concentrated actively managed portfolio is the way to go.
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