Bogle: 'Hope Will Return'

But the index-fund guru says stocks could slide further before the dust clears. His advice: Stay calm—and keep some bonds in your portfolio

The stock market continued its volatile run Aug. 16, with the Dow Jones industrials plunging more than 300 points after problems at mortgage lender Countrywide Financial (CFC) confirmed investors' fears that the worst of the credit crunch isn't over yet. And just as suddenly, major indexes zoomed back in the last hour of trading to finish the day little changed. Amid the scary market action, what's an individual investor to do?

BusinessWeek Associate Editor Emily Thornton asked that very question of John Bogle, founder of the Vanguard Group and a pioneer of index investing. The fund-industry veteran, who recently wrote The Little Book of Common Sense Investing, recommends at least two pieces of sage advice: First, be sure to keep an adequate portion of your portfolio in bonds. Second, try to remain calm: Bogle says it's possible the stock market could slide by another 15-20%.

Edited excerpts from their conversation follow:

We're seeing such problematic credit and stock markets. What do you think individual investors should do?

I would divide individual investors into two classes. If they're speculators, they will be scared and it may get worse and they should probably get out. But I don't feel confident in that advice because I don't give speculators advice!

We clearly have a problem with confidence in the market. Equally clearly, as all market cycles go, we have gone from hope, to greed, and now we're going to fear. Eventually hope will return. And very eventually greed will return. But I think it's going to be a while before we have the kind of greed that we have witnessed in this recent era reappear.

On the other hand, if I was going to give advice to an individual investor—and I make a very important distinction here—if they have come into this market and have invested the way people should invest, and that means they have a little bond position if they're young, and an average bond position if they're in their middle years, and a substantial bond position in their retirement years, then I would do absolutely nothing. They will be protected by the fact that bonds are going up and bonds generate income. No one will take that income from them. They should just hang in there and do nothing.

Even if I was pretty confident that the decline will continue—and I think it's more likely than not—you've not only got to get out right, you've also got to get in right. You must be right twice. So if you get out now, and the market goes way down another 15 or 20%, which is quite possible, they will be so scared they won't get in. So I'm a stay-the-course person. Personally, I'm about 60% bonds and 40% stocks. I haven't changed a single thing in my portfolio. I'm largely indexed on both sides. I haven't made a significant change in my portfolio in six or seven years. On a day like today, I may be worth as much at the end of the day as I was at the beginning because the bonds are up 1% and the stocks are off 2%-3%.

I'm very comfortable when these things happen. I don't much like them. But on the other hand, we have a system where there has been much too much easy credit and aberrant behavior, with rating agencies giving unbelievably casual high ratings to these mortgage-backed bonds. People are apparently able to collect all the poor bonds that don't have great chances of repayment, put them in a portfolio, and by fooling around, nobody knows exactly how, with the order in which they pay off, they're able to create a portfolio that is 90% triple-A bonds out of a portfolio that is in fact 99% C bonds or mortgages.

You pay a price for all this and we're paying the price now.

Why shouldn't I take all of my money out of all of these bond and stock indexes and just put it in cash or a CD?

First of all, you'll probably end up paying a lot of capital gains taxes. And you might be right.