Two weeks ago, Vanguard founder Jack Bogle -- who Fortune magazine named one of the four investing giants of the 20th century -- visited Fool Global Headquarters to talk about the collapse of the stock market.
Bear markets, he believes, separate the speculators from the true investors. Your average speculator is three times more interested in the price of a stock than the merits of underlying businesses -- and bear markets can shake these speculators out of stocks, sometimes forever.
The real investor, by contrast, obsesses over the long-term potential of a business and tries to create true wealth over rolling 10-year periods.
Are you an investor, or are you a speculator?
According to Mr. Bogle, that single distinction makes all the difference in investment returns over a lifetime. True investors -- those who do not try to time the market -- take home most of the rewards of the market.
That's tough to accept after the second-worst year for stocks in the last century -- because we're all hurting, speculators and investors alike. But Bogle's right. When you factor in frictional costs and short-term tax rates, it's extremely difficult for speculators to make long-term money by trying to time their way into and out of bull and bear markets.
Just look at the decline from annual highs of these five truly great American companies:
- Berkshire Hathaway (NYSE: BRK-B ) , down 38%
- IBM (NYSE: IBM ) , down 38%
- FedEx (NYSE: FDX ) , down 38%
- Disney (NYSE: DIS ) , down 37%
- Microsoft (Nasdaq: MSFT ) , down 47%
These are companies with multidecade histories of success. They're five of the greatest businesses in American history. Yet in a matter of just months, their value has been nearly cut in half. And you don't have to dig to find greater calamities. Gannett (NYSE: GCI ) , the publisher of USA Today, is down 80% from its highs. Bank of America (NYSE: BAC ) is down more than 70%.
The world's stock markets right now are a graveyard of broken dreams. And yet, on average, had you attempted to sell these stocks near their highs, to pay the commission costs, to pay the tax penalties, and then to try to time your way back into them, you'd almost certainly have failed. Jack Bogle has proven this over his 60 years of investment scholarship and application.
Investors, on the other hand, suffer along with everyone else when the bear market hits, but let time and compounding work their magic. Just look back on history -- master investors like Charlie Munger and Shelby Davis suffered big losses during the 1973-74 bear market en route to growing portfolios valued in the millions (or, rather, the hundreds of millions).
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Good luck in 2009 -- and Fool on!
Tom Gardner is co-founder and CEO of The Motley Fool. Tom owns shares of Microsoft, but no other companies mentioned in this article. Disney, FedEx, and Berkshire Hathaway are Motley Fool Stock Advisor recommendations. Disney, Berkshire, and Microsoft are Inside Value selections. Bank of America is an Income Investor recommendation. The Motley Fool owns shares of Berkshire Hathaway and is investors writing for investors.