The Little Book of Commonsense Investing.
Jack Bogle’s book, often described as a ‘classic’ is not the most readable of books. Even on Audible at 1.5 speed I found myself drifting off as he tends to say the same thing again and again. But what I did find interesting was his harping on ‘regression to the mean’ as a justification for his theory, when (IMHO) he was using it incorrectly.
What is Regression to the Mean (RTM)?
RTM is a statistical phenomenon that in a dataset with repeated measurements, extreme values tend to move closer to the mean in subsequent observations.
Bogle’s theory is that regression to the mean means that an actively managed (mutual) fund that outperforms one year tends to be closer to the average the next year.
Which is correct, as history has shown.
But . . .
What about the downside?
The corollary is that underperforming funds tend to do better the next year. But do they? Bogle states that 7% of the funds disappear every year due to poor returns. Why didn’t they regress to the mean and get better results? And what does this do to the results?
Survivorship Bias
This is a statistical distortion that happens when analyzing only successful or existing entities while ignoring those that failed or disappeared.
In other words, the conclusion tends to be overly optimistic because failures are systematically excluded.
What Does That Mean?
Because the focus is on funds that still exist (as the underperformers went out of existence) this creates a misleading impression that funds perform better than the actually do as they are only analyzing the better-performing ones. 7% may not seem like a lot, but here is a chart from the book:
What is the thing that jumps out at you? The non survivors are the biggest group at around 80%! So how statistically valid is Bogle’s analysis?
Regression to the mean requires a closed system, meaning all data points must be considered without selective removal. If funds are excluded because of poor performance, then we no longer have a closed system. Hence the use of ‘regression to the mean’ is incorrect in this context.
Why worry?
I’ve just been doing a little research this week on people who have written books or been gurus, and I am not really surprised that there are so many no longer in the market, or have even been disbarred.
Many books are written in hindsight, with cherry-picked situations, but the ones that get me are these ‘classics’ which are quoted everywhere but lack a basic knowledge of statistics.
Hence people who read them tend to fail in the market – 80% of traders lose money and quit within 2 years. 97% of day traders lose money, less than 1% are consistently profitable.
People don’t quit if they are making money.
OK, rant over.
Dealing with Losses
The end of 2024 and start of 2025 was not nice at all, and following ITM there were days when you would have lost money. How to deal with losses?
I can’t tell you what you should do and how you should react – but I can tell you what I do, it may help.
My accounts are a lot bigger than they used to be, and some days I lose way more that I used to make in a whole year when I was working. Sometimes, I find that hard to ignore because you tend to think what you could have done with the money (Helicopter? Chateau? Island?).
Check for yourself
That way lies madness. And fear and doubt. We have the ITM rules, we know exactly when we have to get out, and jumping the gun does no good at all.
If you want to convince yourself, step through the SPY charts for the last few years and note down selling after it has dropped, say, 3% and then getting in again when you felt sure it was all over.
Think in percentages
Think in percentages – I’ve lost 3% is easier to deal with than I’ve lost $300k (or whatever).
I always check what the market did first thing in the morning (I’m in Australia) at investing.com or a similar website.
On losing days I work out in my head what percentage I have lost, but don’t actually login to my accounts to see. Why rub your nose in how much money you have lost? Instead, look at the charts and see what it actually means. Well, it works for me. It may work for you too.
To the markets
It doesn’t feel like it, but the market is just going sideways. We’re still around where we were way back in October last year. Of course, all the drama makes it feel that we are on a rollercoaster, but actually we’ve not really left the station.
SPY Charts
Monday was a bit of a shock, with most of the day’s trading below the psychological level of 600. But it was a nice green candle, meaning that traders got over their initial jitters and turned more positive. This followed through on Tuesday – Thursday – then bam! Friday. happened. After opening up, the market dropped, and we got a nasty big red candle. The one thing that was positive is that it tested 600 but didn’t drop through it.
On the long term chart we see that we are at the bottom bound of the trading channel.
SPYG Charts
SPYG followed a similar pattern to SPY, just not quite so extreme.
The longer term chart shows that SPYG is still in its trading channel.
QQQ Charts
QQQ has been travelling sideways for over 3 months now. It’s getting a bit boring, really. We haven’t yet exceeded the high made in early December.
The long term chart shows that it is still crawling up the lower bound of the trading channel.
VIX Chart (Volatility)
The VIX has settled down and isback in low-volatility territory.
ITMeter
The week ahead . . .
The news is all about tariffs, tariffs and more tariffs, so I’m not going to add to that. Earnings season is well underway, with 62% (308) of the S&P companies having already reported, with 76% exceeding analyst expectations.
The earnings growth rate (based on the companies that have reported plus the estimated earnings of those who haven’t) is 16.4% which is the highest year-over-year growth since 2021. This means that the S&P 500 companies, on average, are reporting significantly higher year-over-year earnings growth compared to the same quarter last year.
There are some big earnings this week, MCD (McDonald’s), VRTX (Vertex Pharmaceuticals), KO (Coca-Cola) and SPGI (S&P Global). No big tech which is what the media go mad over.
The Futures . .
Surprisingly, they are positive in spite of all the catastrophizing about the steel & aluminum tariffs.
Fingers crossed for a good week.
Heather
Q & A
I think I am up to date with answering questions – but if your question hasn’t been answered please ask it below. The Comments widget now shows the word ‘Reply’ and I want to change it to ‘Questions’ but it seems that I’ve got to go in and mess with source code, which I never like to do. But I will have another go this week.
11 Responses
Dear Heather,
Thank you for your weekly blogs as always. I enjoy reading them over and over again and I am also reading your books again and still learning about the ITM methods. The fires and the rains have stopped in Los Angeles and the sun is shining again.
Sincerely,
George Henry
Thank you George!
Hi, may I know if it makes sense to purchase SPLG options instead of SPY?
Hi Heather,
First off, thank you for your book!
I recently made the decision to completely change my investing approach, and now over 90% of my positions are in ITM strategies.
I wanted to check something from Chapter 10 of your book—when do you decide to roll up your position? In the example you gave, where the stock price rises from $100 to $112, the leverage drops from 50% to 45%. Is there a specific percentage increase in SPY/QQQ or leverage drop that you use as a signal to roll up?
Also, if you have a large position, it doesn’t take too long for a small move to the upside to allow you to add an additional contract.
Thanks in advance!
Hi Denis, my backtesting shows that there isn’t a huge difference between rolling up at 42% – 46% so it isn;t that sensitive. The 45% is just a suggestion. I would definitely roll up if you got down to 40% o below.
Yes, great if you have a big account, you can have quite a lot of 50% contracts.
What I tend to do is have a percentage of my account unleveraged (as in straight SPY / QQQ shares) simply because I can’t handle the daily swings or more than $250k without getting nervous – and I prefer not to be nervous! So I allocate the rest of my account to ITM, and a little (<5%) fluttering on OTM just to keep it interesting and make up for the non-leveraged positions.
Hope this helps
h
Hi Heather, It’s quite a coincidence that you wrote about Bogle book this week because I had just bought it and read it. My takeaway was that the average investor is better off just sticking to an index fund like spy. Anyway I had a question about the comment you made about ” <5% fluttering on OTM just to keep it interesting and make up for the non-leveraged positions."
1. what did you mean by fluttering?
2. How does this make up for the non-leveraged positions?
Hi Jim
It is a British expression – I didn’t realize it wasn’t common in the US. Here’s what AI says:
In horse racing, “fluttering” is British slang for placing a small, casual bet**—often for fun rather than serious gambling. You might hear someone say:
• “I had a little flutter on that horse.”
This means they placed a small wager on a race, typically without deep analysis or large sums involved. It’s more about the thrill than serious betting
How it makes up for the non-leveraged positions is that if there is a big move up the OTM options will increase dramatically (see the Bull book,Ch. 5, In and Out The Money , the section on ‘Your First Account’) and stop you kicking yourself for not being more leveraged.
Hope this makes sense.
H
The gentleman that gave me pltr asked me if i bought some when He
( supposedly ) got in… I don’t remember – maybe it was in the 30 or 40’s Anyway I said to him i’m staying neutral ( S & P 500 ( Spy )) the road is paved with good intentions – what they don’t realize is … when the market does finally go down • then i can reverse my strategy
my question to you is what did you invest in when they’re wasn’t spiders – options on the actual S & p 500 monthlies
Goodness Randy – I’m not that old!
SPY has been going since 1993, but I don’t know if it had options way back then. I can remember doing SPY monthly options around 14 years ago? (I think, I don’t keep trading diaries. Actually, that isn’t correct; i’ve started dozens, but never keep them up. Never found them terribly useful.)
Before I started concentrating on SPY and QQQ I used to do stocks, and never reliably made money. I started out on the ASX, but it is expensive to trade and the choice is very limited, unless you want to do speculation on little mining companies. The I discovered the US market (which very few Australians trade – crazy!)
Anyway, I made money and lost it – was never consistently profitable.
SPY and WQQQ are the backbone of all my trading these days.
Hope this answers your question.
h
I just recently purchased your Bull and Bear books. How does one enter the market after the golden cross has occurred?
Hi Michael – not everyone can enter the market when there’s a golden cross – the last one happened 13 months ago! But the ITM rules are that you enter when the golden cross is in force – i.e. there hasn’t been a death cross.
You wont get the same results as someone who started at the golden cross, as you have missed out on 13 months of rises, but bull markets tend to go on much longer than one expects. Have a look at these blog posts: https://heathercullen.com/is-it-too-late/ and https://heathercullen.com/riding-the-bull/.
So, in answer to your question: the bull market may still have a long way to go, you may be waiting years for it to end, so I would suggest getting into the market now. But please read the posts and decide for yourself.
Hope this helps.
h