Links to 20 highlights of this video: John Bogle on Vanguard Index Funds
What a ride! Vanguard index funds have come from a rocky start as they introduced this new concept to the world, to the industry leaders they are today. This interview takes a close look at the business of investment management, and how Vanguard’s index funds compare to the active trading strategy that so many still choose. Here is a summary of the key topics so you can zero-in on what interests you:
- Vanguard Index Funds as a Disruptive Technology
- We are all indexers—even the active traders.
- What happened to long-term investing?
- Is there anything good about trading stocks?
- A paid salesman can always beat the index fund.
- Good managers are in the business of investment management, and not in the business of marketing.
- Behind the scenes of Vanguard index funds? Is it 5 robots, 3 monkeys and a bunch of data?
- Is a cap-weighted index fund bad? Are there better indexing schemes?
- How many index mutual funds should an individual own? What’s too many? What’s too few?
- Social Security and how much bonds to own?
- What about financial advisors for those that don’t want to do it themselves?
- How much should you pay for financial advice? (some eye-opening arithmetic!)
- Does capitalism mix with the fiduciary duty of managing other people’s money?
- We have two guarantees in the financial business.
- When is it appropriate for an individual to buy stocks?
- Interestingly enough, there are no behaviorisms in the field of stocks generally.
- When to abandon stocks because loss of faith in team?
- Is there ever a situation where investor should be happy in a load fund?
- Do you believe we will have a unified fiduciary standard or not?
- The company culture that created Vanguard index funds
A number of you have commented that you like when I include a transcript. It took quite a while for me to make one for this video. I tried my best to transcribe accurately, but any errors are mine alone. I hope this transcript will help you spend your viewing time wisely and get the most out of this video production.
John Bogle, Founder of The Vanguard Group, talks about Vanguard Index Funds in this Motley Fool special interview by Tom Gardner.
Video transcript: John Bogle on Vanguard Index Funds
[Tom Gardner, The Motley Fool]: So 39 years ago, almost to the day, a little bit longer than 39 years ago, you started with the Vanguard group—Jack Bogle, one of the heroes at The Motley Fool, for so many different reasons which will come out hopefully in our conversation and it starts with simplicity, clarity, integrity and a solution that is transparent in a financial industry that works so hard against those qualities it seems, many times it seems. So, what was life like for you in 1974? Can you paint a little bit of the picture of what Vanguard was then compared to what it is today?
1. Vanguard Index Funds as a Disruptive Technology
[John Bogle, Founder of Vanguard, at 0:32]: Well sure, and this will not be very surprising to anybody who’s ever started what we call the modern age, we didn’t use the term then, a “disruptive technology”. And we were shrinking—when we finally broke up the Wellington Management Company into our certain operating units and then Vanguard took over the administration—we were going downhill. One of the directors said, “Bogle, do you realize we are hemorrhaging?” Realize it! We had money pouring out—more money going out than coming in—for 83 months. So you got to be kind of blind, you got to be kind of stupid, and you’ve got to think that it’s great news when a month’s cash flow goes from $20 million out to $19 million out. Everybody condemned the index fund, Ned Johnson said, “Our shareholders would never want a fund with average performance.”
[Tom at x:xx]: “Mere average.”
[John Bogle at 1:32]: And by the way that was the year 1976 probably, when all the Fidelity funds had fallen out of bed and they weren’t anything like average performance by the way, just for the record. And for whatever that, I don’t know, philosophical bent was on his part, it’s nice enough to say they now have a $150 billion Index fund business. So you’ve seen this huge swing: “Helps stamp out Index funds”, bam, bam, bam, like a big Wall Street poster. Everything was negative. The Wellington had been destroyed by our partners from Boston, from an investment stand-point. The fund dropped, and that was the flagship of our Vanguard fleet, dropped from $2.1 billion to $4 hundred million. The performance was the worst in the industry for any balanced fund. There wasn’t a lot of good news around. All the funds were a part of mergers—went out of business—IFS fund finally, funds that people had never heard of, the “dustbin of history” as we say—one fund called Technovest using technical market analysis. Yes, Wellington brought out such a fund and a fund for trustees called Trustees Equity Fund, the first one, and it crumpled like tissue paper in a fire. Think of that metaphor. So everything was bad.
2. We are all indexers—even the active traders.
You had to know your right in the long run. You had to know the gross return in the financial markets minus costs equals net return—pretty smart here. That’s the underlying principle. And you also, I didn’t really phrase it this way in those days Tom, but when you think about it: we are all indexers. Every investor in America is an indexer because 25%/30% let’s call it 25% is indexed but the other 75% only indexed but one at a time. I mean that’s the total market and we have the total stock market fund. You either own it as a unity, or you own little chunks of it and somebody else owns the rest. So will the unity, let’s call it the unity business of the index fund, do better than the trading business? [No,] for all those other people that own the index trade with one another and try and outpace them, which of course can’t be true, and they pay their little helpers and therefore they have to lose. So it’s also clear that it is a “disruptive technology” and it Works. But anytime you try to introduce a new idea: you know first it’s, “it will never work”, then “it will work probably for a short time”, then “the guy’s really lucky”, then finally you know he’s right.
[Tom at 4:25]: Do you think during “the guy’s really lucky” phase, or is there a phase in there where it is “the guy’s a threat”, and we’re going to say whatever we can to confuse people about the solution that he is putting in the market?
3. What happened to long-term investing?
[John Bogle at 4:33]: Well they can try that, but it’s too late for that. It’s too late. You know in the last 5 years roughly $4 hundred billion is going out of actively managed funds and $6 hundred billion is going into index funds, it’s a trillion dollars swing. Just for the part of the equity part of the business it is probably around, I don’t know, $6 or $7 trillion. It’s a huge swing in 5 little years. So the market is responding. Even the people that don’t like it at all are doing it because their client insists on it. And part of the insistence has gone in the wrong direction and that is: we have ETF, which is a way of trading the index fund all day long in real time. What kind of a nut would do that?
[Tom at 5:25]: Well there are a lot of nuts out there though right? I mean, even though there’s been a tremendous growth in index fund assets, simultaneously there’s been a complete diminishment of long-term investment as a principle that is both adhered to by individuals, by professionals, [and] covered in the financial media that way. The average holding period for a stock, or a fund or holdings within an actively managed fund, turnover ratio is north of a 100%.
[John Bogle at 5:53]: It’s actually much higher than that when you look at the cost of it, because that’s the lesser of portfolio sales and purchases that you count as the amount of turnover then divide them into the assets of the fund. And the fact is, whether it’s more or less or even the same, you got those two sets of transactions. You take money out of a stock, that costs money, and you put money back into to another stock and that costs money. So the cost are very very high. The unit cost, in fairness, cost for trading a share was maybe 30 cents to 25 cents in the old days and now they are probably less than a penny. But if you are trading I don’t know . . .
4. Is there anything good about trading stocks?
[Tom at x:xx]: Is there anything good about trading in your opinion?
[John Bogle at x:xx]: Well yeah, I think that the market needs a certain amount of liquidity, and I accept that. But how much liquidity do we need? Do we really need the market to turnover 250% a year? I grew up in this business. There weren’t a liquidity problem; the turnover was 25% a year. So I have been known to say, you will like this expression and taking on, or copying, Samuel Johnson on what he said about patriotism, “Liquidity is the last refuge of the scoundrel.”
[Tom at 7:08]: And the scoundrel is transacting that frequently because . . . ? What’s motivating them, is it human nature and they are blind to what they are doing, or there’s a built-in conflict of interest that’s causing a professional to transact either in their retail client accounts or for reasons that’s inside their fund?
5. A paid salesman can always beat the index fund.
[John Bogle at 7:24]: Well first there’s a lot of ego out there. Even someone you know has a pretty big ego, but he doesn’t use it on saying “I’m smarter than other investors.” But we all think we’re smarter than the guy. We all think we’re better drivers. Sometimes I think we all think we are better lovers—I don’t know about that. But we’re all average. We know that, and have to be and will be. No Lake Woebegone here in the investment business. And then we have this massive marketing machine of paid salesmen who can always beat the index. Because if you’ve got a universe of 500 funds and someone says, “I want the index because it does better”— “Your problem is that you’re looking at the average fund. I will give you a fund that’s above average.” And it’s always easy to do, very easy to do. You know for some period for some fund, it’s the easiest thing in the world to do. So the sales machine, and they have conviction they are doing right thing, but they’ve got to know deep down they are not doing the right thing.
[Tom at 8:23]: Now there have to be some that you believe are doing the right thing on the active management side. There have to be some investors that you’ve have encountered over time that you think: it’s admirable what they are doing—and actually the results, in so far is we can draw conclusion off of a single sample of one person’s lifetime, appear to be above average, sustainably.
6. Good managers are in the business of investment management, and not in the business of marketing.
[John Bogle at 8:45]: Well I’m not sure above average is quite the standard and that’s a really tough standard to meet, but you can do a perfectly good job. And the managers I like, and I don’t hesitate to say who they are, you can look at and you can look at Dodge and Cox, and (what the hell is name of that place Mike down there,) Longleaf you can look that—and clip that out.
[Tom at 9:12]: [laughing] No. We’re going to push the volume up on that.
[John Bogle at 9:15]: You can look at Longleaf. And there are probably a number of other small firms. What is there, what’s good about them? They are in the business of investment management and not in the business of marketing. It’s become a great big marketing business and they stick to their guns and they manage money. They slip, they stumble, they error, they make mistakes. This is a business we are all. But in the long run, I would bet on someone who in the business is trying to be professional investor not a trader, someone who’s business is trying to serve you rather than serve the market place. So there aren’t a lot of them. And you know, I don’t want to put to a curse on them because then they will get too big and then they will not be able to do it anymore. And that’s a little—one of the great secrets of this business—and that is, if you are really good for a long enough time, you draw an awful lot of money and then you can’t be good anymore.
[Tom at 10:13]: Too big to succeed?
[John Bogle at 10:14]: Too big to succeed. Or, as Warren Buffett says, “a fat wallet is the enemy of superior returns.” And, of course it is. So, if you can get someone that can give an index a good run for its money—I would not say you are going to do a lot better, I don’t think they would say they are going to do a lot better—but that’s a good alternative. Because you don’t know with those infinite number of choices. And you know, Longleaf probably runs let me say 4 or 5 funds, Dodge and Cox runs 5 I think, and the rest of us run: Fidelity runs 260 funds Vanguard runs I think it’s around 170, [inaudible], and that’s tough on a whole lot of levels.
7. Behind the scenes of Vanguard index funds? Is it 5 robots, 3 monkeys and a bunch of data?
[Tom at 10:53]: Can you describe, fundamentally, how an index fund works for somebody who’s watching and owns a Vanguard index fund? How’s the process work behind the scenes? Is it 5 robots, 3 monkeys and a bunch of data? Or, are there human choices that are going into the index?
[John Bogle at 11:13]: Well first you can match the index in a very casual way. If, I don’t know, Microsoft is 2% of the index, you just put 2% of the portfolio in Microsoft. And then the same thing is for every other fund—not very complicated. And if you don’t do it with great professional skill, and all kinds of quantitative support, you will do a perfectly good job but not a perfect traffic tracking job. In the long-run you will match the index, but your money beat the index by 50 basis points (half of 1%) in a year and lose to it by half a percent in another. The tolerance is very small. But people like to see, our investors like to see, a tight tracking—and so you do all these quantitative things. They definitely call for, you know, quantitative mathematical skills, particularly when there are additions to the index or subtractions. That happens more in the S&P 500 than in the total stock market—but it’s a very simple thing conceptually. But to do it with something that approaches perfection, it is just what you say: a lot of quantitative people hidden behind the walls.
8. Is a cap-weighted index fund bad? Are there better indexing schemes?
[Tom at 12:25]: If we take the concept of too big to succeed and apply it to a capitalization-weighted index fund, isn’t that a bad idea? Wouldn’t it be better to set up the index fund on a different set of criteria, rather than weighting it by capitalization? Aren’t we buying the largest companies and the most successful companies, which have the smallest future market opportunity, and under-weighting this small potentially up-start disruptive future Vanguards?
[John Bogle at 12:51]: Well you’re saying that the cap-weighting indexes give you a flawed index, in effect, and I guess my first comment would be: since such an index beats the heck out of money managers, what kind of trouble would it be if there were a perfect index? So and then I also say, much more importantly than that, and that is: if the idea of indexing is—as Paul Samuelson described it when he wrote the forword to my first book—you’ll get better returns than your neighbors and sleep better than your neighbors—and your neighbors own the capitalization-weighted index—now, will a value-weighted index do better? will dividend-weighted index do better? Probably it will do better some of the times. I do not believe it will do better in the long-run. That remains to be seen. But when you think about it, if let’s say fundamental-indexing—whatever that means exactly, but a weighting by some company corporation data rather than by market price—still owns essentially all the stocks that the S&P 500 owns but with somewhat different weights—not huge, but somewhat different weights—so they may do better, they may do worse. But if they continue to do better, well what will happen? Everybody will take their money out of the market-weighted index and put it into the value-weighted index and then the opportunity will vanish. That’s the way the markets work. I don’t think it’s going to work. And I don’t think that it’s worthwhile to add that risk. You know, I know what I can get: I can do better than my neighbors. I can own the whole market, that’s a little beyond the S&P 500 but it’s perfectly a good way of looking at it—do better than my neighbors—and should I give that, let’s call it certainty of relative return, up for the uncertainty of one of these schemes that are out there: equal-weighting, value-weighting, dividend-weighting, fundamental-weighting, all kinds of weighting.
[Tom at 14:53]: I kind of feel like equal-weighting would be smart but I guess time will tell.
[John Bogle at 14:58]: It works sometime, we have data going back forever. But don’t let the past data impress you. You know when people start actually doing these things, you know this from your own experience, that what comes out of the lab is seldom reflected in the real world.
9. How many index mutual funds should an individual own? What’s too many? What’s too few?
[Tom at 15:14]: How many mutual funds—of an index variety, let’s say somebody is indexing entirely—how many fund should they own as an individual? What’s too many? And what’s too few?
[John Bogle at 15:24]: Well you can certainly do it with one, and that would be something like the Vanguard Balance Index Fund, it’s 60% total stock market, 40 % total bond market, both USA, and that’s fine.
[Tom at 15:37]: So a person out there could simplify their lives, make sure they are paying off all their high interest debt—it’s gone, and they are saving a portion of their salary each year and they are putting it all in the Vanguard Balance Index Fund. And that three step approach is going to improve the outcomes for the majority of investors out there, number one, and you think it’s completely reasonable to put it all in a single fund?
10. Social Security and how much bonds to own?
[John Bogle at 16:02]: Well, there are obviously a lot of nuances here, and one of them is: if you are younger, I would think you would want to be 80% or 85% equities, and if you are older I would think—although interest rates are so terrible today you have to rethink all these things as the market change—but older may be 25% equities and 75% bonds, something like that. And these are just kind of age based—your bonds position should equal your age—but that’s a rule of thumb, and interestingly enough, it shows a gap in the kind of way these target-date funds, that are very popular today, are structured. Because they ignore the fact that 85% of their shareholders have social security. And if social security, when you begin it, has a capitalized value of maybe—it’s a stream of future payments you will get—may be capitalized at say $350 thousand. If you have $350 thousand totally invested in an equity index fund, you are 50-50. You don’t look at it that way, and your behavior may get you in trouble that way because you got too much in stocks.
But what people should be doing, honestly Tom, is stop looking at the silly stock market every day and look at the cash flow they get. And with social security, those payments are going to continue. They are going to grow with the cost of living. I’m certain as I can be that social security will be repaired soon, because it has to be, and I don’t think that that’s future is in doubt. If you are going to just wake up few of those people down in the Nation’s capital. And for stocks you probably want to look in more of a dividend bias. You can buy a high-yield dividend index, instead of total stock market index, [for] capital flows. And that dividend, if you look at the stream of dividends, it makes the stock market look violently volatile.
The dividend stream goes up, up, up. And the fact of the matter is, there has only been two significant dividend cuts since 1925: one was in 1929-32 and the other was a few years ago from 2007-2009 when all financial companies pretty much eliminated their dividends. We’ve already recovered from that, that’s over. The S&P 500 is paying more dividend now than it was before the drop. So all these things are clear in the past and in a lot of ways that does not matter. But if you assume that American business grows, and America grows, that the dividend stream will keep going up and, as people ask all the time, corporations are sitting on huge amounts of cash so dividends should not be jeopardized—absent some real problem in the world and the economy—and people should be aware of that. You know, nothing is a lead-pipe cinch in this world but you have. It’s actually sort of amusing. You have a couple of big risks out there: you know about the economy, you know about international—kind of hanging on by its own, you know about the dollar, you know about the Federal reserve buying all the securities and trying to bid the prices up of assets—not a particularly wise move—and you have to assess those risks and try to make some kind of judgment, however difficult, about how they come out. But you also have to realize a couple of things . . . Well, a second set of risks is really the incomprehensible risks like nuclear warfare or a meteor right, hits the USA, well . . .
[Tom at 19:40]: Or robots, robots begin to control our society?
[John Bogle at 19:44]: It won’t matter whether you have stocks or bonds or anything else.
[Tom at 19:47]: A club, you’ll need a club.
[John Bogle at x:xx]: Yeah just a club. So there are all kinds of big or small risks. But as I have often said, you know, we are sitting here knowing that the world is going to hell in a hand-basket—but people have been worried about that since the beginning.
[Tom at 20:04]: The known fears are not the ones to really fear. So are you and by the way Jack I truly can’t believe that you’re 84 years old. Are you 84% in bonds?
[John Bogle at x:xx]: No.
[Tom at x:xx]: So you are violating your advice? I’m kidding.
[John Bogle at 20:16]: You know, it’s my rule thumb. And, of course, at 84 your social security doesn’t have a capitalized value of $350 thousand either. I would like the next check to come in. My wife doesn’t think we should take the checks, but you know, we postponed them until we were 70. And we really got a nice, I can live on what I get from social security, because we live on a fairly modest way—modest by the standards of, very modest compared by the standards of what you see in the financial world, and the corporate world—but pretty nice compared to a typical American worker and so it’s, you start with the rule of thumb.
[Tom at 20:59]: And you work back for?
[John Bogle at 21:01]: And then you work back and then you got to think about it. And I don’t know, I have not figured it out Tom, how to do it. But when I first introduced this rule—I can remember back in 1999 at Morningstar, I told him that I was reducing my equity position from about 75% of my holdings to, I think, 30% of my holdings—because the stock market was selling it 35 times earnings and bond market was yielding 7%. And I looked at the transcript a while back and I said, you know honestly, when I look at the math I don’t see why anybody would hold any stocks at all. Because at 30 times or 35 times earnings stocks were not going to give you 7% return in the first decade of the 20th century.
[Tom at 21:51]: And now you live with the numbers and you are not really sure what to do about them?
[John Bogle at 21:55]: Well now, you know, my own position is that stocks are more or less fairly valued—probably a little on the high side but more like, depending on whose number you are using, 15 to 17 times earnings maybe 18 times earnings—it’s a long way from 35—half. And bonds are not yielding 7%. They are yielding, depending on what you want to look at, 3% to 2.5%—3.5% depending on the corporate government mix, maturities, and other things of that nature. So you have to think a little bit differently. But I have not done anything about that. I don’t change my portfolio.
11. What about financial advisors for those that don’t want to do it themselves?
[Tom at 22:30]: I want to talk a little bit about financial advice and how that side of the business works—because Vanguard has [been, or] is at least perceived to be, exclusively a mutual fund company. A lot of individuals are trying to figure out how to put a portfolio together. It’s helpful to hear the number of funds that you would put into an account for an individual, and it’s relatively small and it should be manageable and a decision that an individual can make on their own. But yet, many people come to their finances and say, “You know, please Jack, just do it for me—like I will literally give you the authority to make all transactions in my account. I don’t want to know anything about it.” Which, of course, sets up a lot of people to be taken advantage of by financial advisors. So what do you think of the financial advice side of the decision making process?
[John Bogle at 23:22]: First, let me just take this—maybe you think it’s a kind of nuance—but I got a letter from a shareholder the other day saying, “You keep telling me I only need 3 or 4 funds. Why do you have 170?” I [made this] simple example for him: we have like 60 bond funds, 60. Why is that? Well we invented, created or developed, the system of “you tell us the maturity, how much risk and how much income you want.” So you get short, medium and long, and also a couple of variations around that, and then in the municipal area you only have the fund themselves which [pertains to] different states, and then we got some bond index funds. We probably have 60 bond funds out there. So an investor has to know—and, you know, do the math—should he be in municipal bonds or in taxable bonds. It’s a very important decision. And, right now, municipal bonds look very attractive simply on the numbers, those kind of numbers. And then you have to decide how you want to balance risk and return.
Obviously the highest yields, no matter how depressed they are, are in the long bonds—but the greatest risk is there and the lowest yield is in short, but the greatest principle stability is there. So those are decisions investors really have to really think a little bit about. It’s just not—I mean, you can even buy the bond index, to be sure, and that’s turns out to be an intermediate-term bond fund in fact, and that’s perfectly satisfactory. But, you know, we kind of nuanced ourselves to death a little bit. And, you know, you should, in terms of taxable and tax exempt, deal with that issue. And I would say, to simplify, most of the investors should be in tax exempt—just because they yield significantly more than treasuries even before you take into account the tax exemption. So I think they are attractive. And maybe you want some treasuries there, just as a bulwark and you buy a treasury bond fund. And it gets to be a little nuanced.
12. How much should you pay for financial advice? (some eye-opening arithmetic!)
[25:21] I think the interesting question is, if you want financial advice, how much should you pay for it? I mean, you know, let me give you an interesting little piece of math. I look at the stock market investment return as a 2% dividend yield at the present time—low but not nearly as low as the 1% we were on—and a 5% earnings growth. That’s a 7% investment return. And over the next 10 years I don’t think it’s going to go up because of higher [price/earnings ratios] or down because of lower PEs, not that much down anyway, and so there won’t be any speculative return by my reckoning. So we’ve got 7%—that’s nominal [return]. And so we go to real [return]. And if we are lucky enough to get 2% inflation that’s 5%. A typical fund manager is taking 2%. That leaves 3%. And if you give 1% to an investment advisor: that’s a third of 3 and you are down to 2%. And if you are a fund picker: you lose around 2% by jumping on the latest bandwagon and 2% minus 2 is the number that I won’t recalculate for your audience.
[Tom at 26:30]: It’s a reminder of Warren Buffett saying that the financial services industry is an extractive.
[John Bogle at 26:36]: Sure. The economists called it a rent-seeking industry. Of course, it is. It has to be. It has to shrink, and it has to get its cost down. The trading volume has to come down, and a lot of mutual funds they are going to have to fight—they are going to be cash cows. The big mutual fund companies are fantabulously profitable and they can’t change what they are doing and do what we do because that would not be profitable to their owners—either financial conglomerates or all those partners at Capital Group or the Johnson family up at Fidelity. I mean their wealth is like $20 billion or something, putting the family altogether. They have done great in this business. Whether their shareholders have done great, that is the question that interests me. That’s where we should be focused. And financial conglomerates is the same thing. They basically try to destroy this industry. They own 30—well, 40 of the 50 largest fund groups are publicly held and 30 of them are [owned] by conglomerates. Think about buying a fund that’s run by a financial conglomerate. Why did they buy their way into this industry? [inaudible] They wanted to jump on the wealth bandwagon of managing money and they will accomplish that, whether by hook or crook. If their return-on-capital threshold is 15% and they pay a billion dollars for a mutual fund company, they will have to take out $150 million a year. And it’s easy. There are all kinds of things you can do.
13. Does capitalism mix with the fiduciary duty of managing other people’s money?
[Tom at 28:09]: You are a fan of capitalism. So if we look in the market place in finance, and compare it two actors out on the stage: one of them is a fee-only fiduciary financial planner with a basic flat-fee dollar amount that sits down and builds a Vanguard-based index low-cost portfolio acting as a fiduciary, the other is a financial advisor or a broker. I’m reminded of three that came to a book signing in San Diego years ago of ours and said, “You know, you talk about Vanguard index fund. It’s really funny to say that we now manage money. We have left the firm that we were at.” In their case they were with Merrill, and they said, “We couldn’t sell the index fund to our clients because we couldn’t make any money on it, but we all owned it ourselves.” So it’s almost the—it’s the complete reversal of the fiduciary. It’s like: I will be fiduciary for myself, and then fiduciary with my relationship with you is, “Hey, if you buy it, if you are willing to buy what I’m selling, then I have not done anything that I should feel badly about.” So the reality though in the market place is that the first actor, the fee-only financial fiduciary, is living a relatively low, lean, you know, existence in terms of the financial make up. And the VP of the big investment firm has a country house and is making millions of dollars a year selling load funds and a whole bunch of booby-traps in the portfolio to keep you locked into different products. So how do you observe and what conclusions can you draw about capitalism given that?
[John Bogle at 29:44]: Well capitalism is a very funny, is a very funny manifestation when you get to the fiduciary duty of managing other people’s money. You know, most systems when you begin with a new idea, for example, if you want to get it sold, you pay the salesman a lot of money, you advertise a lot, and you deliver 70 cents on the dollar, or something like that. And then in the investment business, the investment business is really a business sort of a mathematical candor. You can’t hide. You know, if you are selling a Mercedes Benz, the salesman is selling it, he is going to say: “Look at the value here. Your neighbors are going to be envious, blah, blah, blah, whatever it is.” And you would like the diesel fuel, or the doors slam nicely, or it’s got a great sound system, or air conditioning, I don’t know what. But in the financial business, value is one thing: dollars. It can be measured. Unlike all these esoteric things that characterized capital. And once you get the measure of value, the problem becomes a very simple mathematical problem. And how you get people to focus on that is a good question. How you get them to focus on the role of cost in that is a good question. How do you get them to think about the long term, because in 2, 3 or 4 years, the difference in cost, let’s face it, it just doesn’t matter. But over your investment lifetime, getting the market return in the index fund, or almost to the full market return, compared to paying 2%—which is roughly the right number for a managed fund֫—it means that you get, in the latter case, about 30 cents on the dollar, 30 cents. But you have got to look at 40 or 50 years. But these young people today, say they are 25, 50 years is just 75 [years old]. That is too short! They’ll live to 95. They should be looking at 70 years. And these numbers just get further and further apart.
14. We have two guarantees in the financial business.
you do need a lot of people, they need help. There is no question about that. But I think we have to rethink how we pay for that help. And, you know, maybe the 1% is much too high. Or at 1%, if you have a client with 25,000 dollars, 1% is probably not nearly enough. So, I think that eventually you’ll have a fee-for-service kind of thing—like a typical professional service: lawyers, accountants and so on. Neither profession to which I am particular smitten with. They’ve gone that way, that’s the way that they conduct their businesses. It is more a professional approach than a business approach. But don’t try and get me to tell you there are easy answers to this. You need help out there. People need their hands held, there is no question about that. And paying a little bit for it, is probably better than doing nothing—just trying to do it yourself. And the worst thing of all, is not investing at all. That is the one guarantee we have in the financial business. Well there are actually two. One is: if you buy the index fund you will get the market return, and guarantee two is: if you don’t invest, you will get nothing.
[Tom at 32:44]: One of our members, Neil, wants to know what you think of—well let’s take the family I was raised in, which was thought from a relative early age to buy stock directly. I make the arguments on behalf of it, and Neil wants to know what you think of that argument? Where do you see strengths and weaknesses to it? And feel free to knock it down entirely. You will just be knocking my whole life to the ground if you do.
[John Bogle at 33:05]: Will I really be doing that?
15. When is it appropriate for an individual to buy stocks?
[Tom at x:xx]: No . . . So, we were raised in a family and thought to invest in stocks. It was a low cost alternative, a one-time payment, and we were taught to—I guess one of the primary pieces of advice I give to any investor buying stocks is double your holding period right now. And if you want to do it, right after you have done that: great, double it again. Because just as it with a great fund, a great business should be held over at least 5 years to really see the value of the organization play out in the marketplace . So, we were thought to buy stocks. The low costs, one time transaction, find the great businesses with a great leader — Howard Schultz has been in Starbucks, John Mackey at “Whole Foods”. These businesses have compounded incredible returns since they came public 20 years ago. And you know, hitch your wagon to the stars of these really great, often consumers’ facing businesses that we can follow. You have to do a lot of numerical work—evaluation, etc—but that’s how we have been building our portfolios in our family. And so [that’s what] our perspective is ,and Neil wants to know,
what do you, “When it is appropriate, in your opinion, for an individual to buy stocks? Is there a level of expertise or interest, an amount of time you should have, or capital, or it should be a side frivolity in a base portfolio of index funds?”
[John Bogle at 34:28]: That last sentence captures it best. And that is: you should have a serious money account, I am going to even call it a boring money account, where you put money in the stock market index fund and balance that a little bit with some bonds depending on age, and so on. And don’t look at it. Don’t look at it for 50 years. Don’t peek. But when you retire, open the envelope. Be sure a doctor is nearby to revive you. You will go into a dead faint. You won’t believe you have that much money in the world—and that’s where we fool ourselves. That’s a serious money, boring money account.
[35:03] We have a gambling culture here in this country, or maybe every country does. You see it in its finest manifestation, or maybe I should say its worst manifestation, in the lottery—state lottery. Las Vegas contributes its share. The racing, the races contribute their share, the track. All this is just gambling where, you know, a lot of people bet their money and a lot of people take their money out. And the croupier wins a thousand.
[Tom at x:xx]: 3 to 20% of whatever is. You put a dollar in.
[John Bogle at 35:38]: So, I would say have a funny [money account] if you have a gambling instinct, and most people do. At least start off—I mean I’d say start off with an index fund, period. And for 5 years don’t do anything else. And then look around, see what’s happened in the 5 years. See how you felt when the market dropped 50%; see how you felt when it came back. Those 5 years periods are going to be very different for one investor and another, because they are all over time. But then, when you get there: 5% in the funny money account.
[Tom at 36:09]: What would have happened to Warren Buffet if he had done that?
He would of, A tremendous amount of value would not have been created by his understanding and ability to evaluate a business for investment.
[John Bogle at 36:20]: Well, name 2.
[Tom at 36:24]: Well, Longleaf, you mentioned Longleaf. Dodge and Cox.
[John Bogle at 36:27]: But they don’t have the sensational return, probably they have something above par returns, but maybe below part from time to time. So, and then don’t forget Warren’s case, he wasn’t running a mutual fund. The mutual fund is a badly structured business for investment management. We say, and this is the way it has to be really, you can take your money out whenever you want, and you’ve got to be ready to put it in whenever you want. And see, you ride on these waves of optimism and good performance, then when the money comes in up here—and then reversion to mean, which is a big part in one of my recent book, a big part of the final chapter in my recent book “The Clash of the Cultures”, and that’s happened everywhere. It has happened in the Magellan fund, it has happened in T. Rowe Price Growth fund, and it has happened in our Ivest(?) fund, it has happened in Fidelity Trend fund (Ned Johnson happened to have run). It happened in CGM, all the hot funds, they were all in there for the last 25 years, and they all look like this [hand gestures up then down]. Overlap, put them over each other, looks like the Himalayan mountains. The reversion to the mean is a constant pattern.
[Tom at 37:33]: For the individual, I am just going to poke around here a little bit just to get your full philosophy. For the individual, it is unlikely that you are going to hit the mountain top of the Himalayans with your portfolio, so you may not have to ever see the other side of the mountain top, unless you have so successfully invested that your personal account is moving up in a billion dollar asset.
[John Bogle at 37:50]: Let’s say you bought Magellan before it was for sale, which is where that record begins by the way. There is a lot of phoniness in this business.
and You are going to enjoy the mountain. And you are not going to know it is a mountain. But when that mountain gets up there [you’ll think]: “My God, this—I have found the Holy Grail.”
[Tom at 38:10]: Now, I am really going to go all in.
16. Interestingly enough, there are no behaviorisms in the field of stocks generally.
[John Bogle at 38:11]: And now, I am going to go all out. So, there is a lot of behavioral kind of stuff, not to use too fancy a word, in the mutual fund industry. Interestingly enough Tom, there is no behaviorisms in the field of stocks generally. How could that be? That is because, “I am a dumb behavior; the guy that buys my stock from me is a smart behavior, we offset each other.” It is not as if I can make a behavioral mistake without somebody else making a successful behavior thing, the other side of the trade.
So, you know, I think we take a lot for granted—we listen to all these theories—and big, old, boring indexing is the answer.
[Tom at 38:56]: Have you ever bought individual stocks, and/or actively traded funds, and if so what do you look for in those investments?
[John Bogle at 39:03]: When I came into the business I had friends in the brokerage business, I bought this and that and the other thing. And then I had a broker. And he would tell me, “This was good; get out of that; and get into that.” And it wasn’t that they did badly, which is of course what they did, but I just couldn’t stand to have my phone ring when I was trying to do my work. So, I haven’t owned any individual stocks since, let me say, 1960. I don’t know exactly, a long, long time. I’ve never bought anyone else’s mutual fund—although I did buy, like a nice backup investment for my son John’s, John Bogle’s fund. I guess Bogle Small Cap Growth. So, I did that and it has done actually rather nicely. Of course, he’s very smart. And, so that is about it.
[Tom at 39:52]: Even, the most successfully, actively traded funds at Vanguard have a period of 3 years, sometimes even 5 years, when they’ve underperformed—but net-net they’ve outperformed. In the case of outperforming actively managed funds that, let’s just say that they have a few qualities that we would probably both love: a very low turn-over,
sustained, you know, tenured leadership, a very fundamentally businesslike, analytical approach. But even in those cases where the fund is very well run, or even Warren Buffett-Charley Munger are going to have a year, or a period of a couple of years, potentially, where they would lose to the market. What is the appropriate amount of time to hold something before saying: “This team doesn’t really know what they are doing”?
17. When to abandon stocks because loss of faith in team?
[John Bogle at 40:39]: Well, let me start off with—I should explain Vanguard’s philosophy as I implemented it, not how they necessarily do today. And that was very early, after we closed Windsor fund back in 1985—it was getting too big and they started Windsor 2—and everybody said that it wouldn’t do nearly as well as Windsor and, of course, it has done better, a little. They track each other very closely so I don’t want to make an issue about that. And then we had US Growth—and that was run by Wellington, we decided we needed a new manager. And I wasn’t so sure about them, so I did what set the standard for everything we did since then, everything I did since then, and that was bring in another manager, and then another manager, and then another manager and another. So, we had a lot of equity funds that had 5 managers. It’s not that it’s easy to pick 5 managers, but if you are comparing yourself with the universe of—let me say large-cap value funds—and then there are 50 funds in that universe, 5 [are] going to have the same returns, it is kind of a large numbers thing.
[41:38] So, most of our equity funds have 5 to 7 managers. So, there is not much premium in manager selection. You hope they will do well—we happen to be having a good year, we are having a good year this year. But we had a bad one, because that is the nature of the business. What you don’t want is something that
is so departing departs so far from the market, particularly on the up side. You don’t like the down side, but on the up side, it draws money in. It brings in this investors who are looking for the next big thing, the next hot thing. So, we win by about a point-and-a-half a year on average, not because we pick better managers but because we have very low operating cost, our expensive ratio. We negotiate the fees way down with the advisors—the fee rates, because the advisors are not starving to death, in terms of the dollar fees. And then we’ve looked, as you said, for long term managers with lower turnover, and then we had no loads. So, if you look at all those numbers, if they are good enough to be average (or lucky enough to be average) we win by about a point and a half a year, which is 10% over ten years. And I always thought that it was good enough.
18. Is there ever a situation where investor should be happy in a load fund?
[Tom at 42:42]: Awesome. Is there ever, just a few more questions, is there ever a situation that you can imagine where an individual should own a load fund? They’ve sat down with the financial advisor and now they would watch this video and looking through their portfolios, we are talking, and they see a number of funds that their advisors put them in, they carry a load. Is there ever a situation where they should be happy about that?
[John Bogle at 43:06]: I would say unequivocally not. You can look back, the advisor is going to sell you a load fund—he says, “This no-load stuff is bunk. Here is the no-load index and this fund, even counting the 5% commission which is roughly what they are today (although a lot of that has changed with the advisory fees), and even with that 5% commission, we did 50% better.” Well, hind-sight is always 20-20. If they can’t find a fund that beat the index—I don’t know—they can’t be very acute, they can’t be paying too much attention. It is the easiest thing in the world to do. But don’t believe it. The past is not prologue. And actually, if you look at the numbers carefully enough, long enough and thoughtfully enough, you will see the past performance of a fund is anti-prologue. The better it is in the past, the more the regression is going to be, the greater that it is going to be in the future.
19. Do you believe we will have a unified fiduciary standard or not?
[Tom at 44:00]: Do you believe that we will have a unified fiduciary standard or not? Are you optimistic about that? Maybe you explained, I think that you explained what it is for some.
[John Bogle at 44:09]: Well, the, let me just say this: the issue is a very narrow issue at the moment. And that is, the fiduciary standard for people who are selling funds, investment advisors, fees of only investment advisors, stock brokers, things like that, it’s the firing-line level. I think we are making a very big mistake, I have written to the SEC 3 times about this, and that is the biggest problem of the fiduciary side it is on the fund manager side. We need a federal standard of fiduciary duty for fund managers. And if you look what has been happening at the labor department, and I have talked to them down there about this, a fiduciary duty for a corporation, for an evaluator, for this one and that one, but no fiduciary guide for the guy where you really need a fiduciary duty: for the fund manager.
[44:57] So, we do need fiduciary duty. That would tend to get us out from this morass we are in, of short-term trading, of high cost, of speculation versus long-term investment—because it is the antithesis of trading. And it would probably eliminate the conflict of interest that is obvious if your fiduciary has 2 sets of fiduciary duties. One is the fiduciary duty for the mutual funds, and the other is the fiduciary duty to the shareholders of this publicly held company, a publicly held conglomerate. That fiduciary duty—those 2 fiduciary duties—are in direct conflict. And so we of course quote the Bible: “no man can serve 2 masters.” And then we add to that what Matthew said right after that, or Matthew quoted the Lord as saying right after that I suppose and that is: “for he will hate the one and love the other”. Now in this business, who pays the portfolio managers, who makes all the money, who has all the public stockholders? The manager gets all the love. And I wouldn’t say they hate the shareholders, I wouldn’t say that at all, but they would say love the managers more.
[Tom at 46:11]: I want to just talk in the end a little bit about the fact that you have been a business leader. We talk about investments, but you started a company and ran that business, and it has 2 trillions dollars in assets today and a 14 000 employs. So, that is massive, I mean is sure way beyond of what you would have dreamed of back in 1974,
[John Bogle at x:xx]: Correct.
20. The company culture that created Vanguard index funds
[Tom at x:xx]: although I am sure that you were optimistic about your chances of giving the solution you created. But how do you evaluate talent, the people that you work with? What are some of the cultural features of Vanguard during your leadership?
[John Bogle at 46:44]: Well, one of them is exemplified by a story I tell about the time we got to around 200 employs. We really would have had a Personnel department, Human Resources it is called now, it seemed like a good idea. And I was really a dictator, so I looked around and trying to see who was not busy in the office—very strapped for spending any money—and there was a secretary in the legal department, a very lovely woman. And I talked to her lawyer—we had only one lawyer then, we have 140 now. That is called progress. And I said: “Can I use her to run a little personnel effort?” And he said: ”Yeah, I think she can do that.” So, she gets into my office: “I would like you to do this”. “Whatever you want Mr. Bogle”. So, we talked a little bit and she started to go out of the office and she was about to walk out the door, and she turn around and she said: “You know, I want to do whatever you want me to do Mr. Bogle, but I don’t know what it is you want me to do.” And I said: “Well, I am not sure I know either”. This is what happens when you are a very small company, and I had a lot of things on my mind, of course. And I said: “I don’t know what it is that I want you to do but let’s start with this, hire nice people and then make sure that they hire nice people.” And that is the best I can do on this.
You know, most of the jobs at Vanguard—some of the technology jobs require a whole lot of professional skill—most jobs can be done by intelligent human beings, with little experience and the motivation to do them. So, I look at Vanguard as not being some, you know: “Can we hire the best and the brightest?”—I’d say that’s a big universe, and we probably have a share of them—but you are trying to get people you can work with and who work well with others. They are going to maybe try and not make the same mistakes as you did. But it is, you know, the change from a little tiny organization, embryonic organization where there is a captain and the rest of the oarsmen down below, on the galley. And that is obviously oversimplified. But
we are very, our mission is very simple, our presentation is very simple. When you think of what we can explain to people—what they should do in investing—it is right out of the proverbial horn book, the ABC’s of the old days. And it works, it is understandable and it is guaranteed to give you your fair share of whatever returns the stock and bond markets are generous enough to give us, or mean enough to take away from us.
[Tom at 49:49]: There is a Gallop survey that shows that 7 out of 10 people going to work in America today, basically say they are indifferent or even down right negative about the organization that they are working for. So, in a funny way, in that rowboat scenario where we are all rowing together, in many organizations more than half of the people don’t even really care about what they are doing. So obviously you have found people who are passionate about their principles.
[John Bogle at 50:14]: We have more turn over than I would like, but that happens at these middle job levels. People are well paid, they get terrific benefits, the partnership plan—they share in the earnings we generate for shareholders. And I still spend an hour with each Award For Excellence winner, a program that I put in there all those years ago. There are probably about eight a quarter. So, I get to sit down and talk to 8 people a quarter. It may not sound like much in an organization that big, 32 a year, 320 in 10 years, 640 in 20 years. So, I feel that I have pretty good . . . Now these are exceptional people, that’s why they got the Award For Excellence, so I am not kidding myself. But we have human conversations, talk about commitment, talk about opportunity, talk about the lack of opportunity, talk about anything they want to talk about. And there are among the most engaging and pleasant moments in my career.
[Tom at 51:12]: You are in the unique position of having started, run the company, and now sit as an observer of your creation. Succession is such a big issue for so many. We have a lot of
businesses, small business owners that are at the Motley Fool who are thinking about that. What have you learned, what do you think about? I mean you are in a very, I think in a very, I find it to be a great thing that you have minor lovers quarrels with things that are happening at the company that you created. Which I think it is an intellectual stimulating must be for you and for the organization to think and so, how is that experience for you?
[John Bogle at 51:47]: Well, it is difficult. Let me be honest about it, it is difficult. I had to fall back . . . The company it is not particularly smitten with my directness and my outspokenness and my books.
and so People don’t like criticism generally speaking, but I am just trying to tell it the way I see it. And I would say my book, “The Clashes Of The Cultures”, almost entirely reads like a great, big commercial for Vanguard. Well, there are some things that they don’t like in there. I am talking about the Wellington fund fee increase, which I believe it was unjustified. I am talking about our proxy voting policies. I am talking about the possibility of having a transaction tax, and a bunch of other things that are similar to that. So, I had finally had to develop a response. And when someone says: “Well, I understand you disagreed with Vanguard on that point”. I would say: “Absolutely not, I would never disagree with Vanguard. Vanguard disagrees with me.” And it’s their right.
[Tom at 52:54]: So, you are optimistic about what Vanguard will become over the next 100 years?
[John Bogle at 52:59]: Well, where we are, I mean I have you have to be optimistic. I mean there are risks out there—when they were trying de-mutualize the company. That has happened in a lot of places. I don’t think that it’s going to happen there, but anything can happen on this world when you get human beings involved. I think it is important—even as we maintain the letter or the implementation of a mutual structure—we have to maintain the spirit of that mutual structure too. And that requires some doing. You’ve got to keep your mind on the mission, and your mission is to serve day after day after day. It is very difficult to see anything that can get in the way of that, except some massive thing like a huge stock market collapse—it would not be good for us. And every once in a while we depart some of these new funds—I have a little question mark about. You must be betting better than the index fund. I would not even look, I would just say, “I bet they are not,” because nothing can be, in the long run. So, you know, I watch. I think people at Vanguard really, I don’t want to overdo this, but I think that they love me. You know, I am a normal human being, more or less normal anyway. And I am straightforward—they can identify with that—and, you know, even the people that have been there for a very short period of time seem to know who I am.
[Tom at 54:27]: It is total authenticity, which means sometime we will agree, sometime we won’t agree.
[John Bogle at x:xx]: Yeah.
[Tom at x:xx]: It is I remember a member of ours, Vicky, was bringing up the importance of skin-in-the-game. You had skin-in-the-game with the business and have your capital with the Vanguard’s funds to this day. So, the mix of those qualities, even though it may lead to some public disagreement, it is overall a benefit to both, the organization, to you, and to the outcome for the customers of that.
[John Bogle at 54:55]: I really don’t care who benefits and who doesn’t benefit. I have to tell it as I see it. I was able to do that for a long, long time. I was key to
Vanguard’s—well actually Vanguard’s going into business. You know, you walk a road that you think is the right road. You walk it as straight as you can. You be as honest as you can. I have gotten so, I have found confessing my mistakes—which number in my career, well, I don’t even want to get into hundreds, thousands, I don’t even know how many I have made , infinitely maybe numbers in my career. You know, it is kind of liberating to say I really blew that one. And I blew a lot of stuff. But the underlying thesis, if you will, the underlying concept, the underlying idea of owning a market, whatever the market may be, and getting your fair share, has worked and it will work. Who else can say that about what it is going on in their own company?
[Tom at 55:46]: Small failures all the way to great success. My final question: How are you spending your time now? I mean, an incredible part of your story which we haven’t talked about but when we talked to you on the radio, you know, your human heart? How old is your heart right now?
[John Bogle at 56:03]: Well, my heart is, I got it when it was 26 and I’ve had it for almost 18 years.
[Tom at x:xx]: You are younger than I am.
[John Bogle at x:xx]: 42, yeah. But I am starting to feel I little more like 84. And you know the trail in recent years has been a little difficult, physical trail. I had some very profoundly, serious problems and long hospitalizations but you go into them optimistically. My wife is a powerful support and my kids are wonderful. And you get over the bumps, you are always optimistic. You know, the idea when you go into a hospital again, is they put you down on the gurney and you just go: “Here we go again”. And like the whole business of the transplant, my reaction is just the same Tom. If I thought jumping up and down on the kitchen table and screaming and yelling about the unfairness of life will help my condition, I would do it. But it occurs to me, it would make it even worse. So you kind of go along. You speak out with honesty. And I am not trying to say something to hurt somebody, but I am not going to agree with something I don’t agree with. And you know I think that Vanguard benefits from that immensely. You know, the shareholders, still close to a lot of them, still get a lot of correspondence, still writing a lot. I have an article about to come out in the Journal of Portfolio Management. Another article about to come out in the Financial Analyst Journal. I’ll forward to you a book about Paul Cabot, one of the founders in industry I wrote the forword to. And a book about John Maynard Keynes, published by Oxford University Press in which I wrote the final chapter called “Adam Smith and Capitalism”. And I did a forword for John Waxes book on Keynes, John Maynard Keynes as an investor. You got Keynes, you got Adam Smith, I got one of the industry founders, I got 2 academic articles and I am starting to worry that I am going to run out of things to do.
[Tom at 58:18]: I don’t think that is possible Jack. And, you know, anytime you need any extra work that you want to do, just come and hang out with “Fool’s”.
[John Bogle at x:xx]: Well you have been a very good “fool” Tom.
[Tom at x:xx]: Well, it all started with Bogle’s Folly so there is…
[John Bogle at x:xx]: We are associated.
[Tom at x:xx]: We are bound by name. Jack Bogle, thank you so much for taking time. We could continue this conversation for another hour, but let’s let you go home with your day.
[John Bogle at x:xx]: We are tired. We are tired. Thanks Tom very much.
[END OF TRANSCRIPT]
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