With John C. Bogle, Founder and retired CEO of The Vanguard Group, Author, Investor, and Philanthropist
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A WORD FROM STEVE POMERANZ
You may have heard that last week the man who created the world’s first index mutual fund—which eventually became known as the Vanguard S&P 500 Index Fund—passed away at age 89.
His name was John Bogle and was Founder and Chief Executive at The Vanguard Group.
John was recently a guest on my program and was one of the most important investment thinkers that I have followed throughout my career.
John was a fierce advocate for the average investor, and although it took me a number of years to appreciate his thoughts, I became a staunch supporter about 20 years ago.
You see, I started my career in the belly of a large Wall Street firm. Back then it was (and still is) a sales-driven world. Customers were looked upon as generators of revenues, and sales practices emphasized maximum commissions regardless of the client’s real interests.
Also, back then mutual funds were the accepted method for money management and diversification. Money managers who were able to post stellar returns were treated as celebrities and gurus offering the chance for us to ride on their magical coattails.
Mutual Funds in those days would be sold with large upfront commissions and high internal expenses which would essentially strip away much of the return the fund investor would receive.
Into this world stepped John C Bogle. While he was not an advocate of Index Funds in the beginning, once he decided it was the right thing to do, he took to it with a vengeance. He started The Vanguard Group and began offering the first inexpensive index fund as a No-load fund—meaning there would be no upfront sales commission.
His insistence on integrity and his unwavering drive to continually lower costs would make him many enemies in the business and many friends among the do-it-yourself investment community.
As individuals like myself broke away from the Wall Street culture and started our own Registered Investment Advisory firms, index investments started to gain acceptance in our profession. I am proud to have contributed a small amount to this historic movement.
So, here is my recent interview where John reminisced about his trip to the Berkshire Hathaway Shareholder Meeting and his career in the investment industry.
I know you will find his humility and his down-to-earth way quite refreshing.
Summary:
Steve has the rare honor of interviewing John (Jack) Bogle, a true living legend. Bogle founded The Vanguard Group in 1974. He created the first index fund in 1976 called the Vanguard S&P500 Index Fund. He was named one of the investment industry’s 4 “Giants of the 20th Century” by Fortune magazine and received Institutional Investor’s Lifetime Achievement Award. Bogle is also a strong advocate for the average investor. He has authored numerous books on investing and is the recipient of many prestigious awards.
Warren Buffett Honors John Bogle
Two years ago, Steve Galbraith, one of Bogle’s friends, told him to “save the date” for a surprise. About a year later, Galbraith showed up with his luxury Cessna Citation jet and flew Bogle, a few close friends, and family members out to Omaha to the Berkshire Annual Meeting.
At the meeting, Buffett and Munger took their places onstage and shared a summary of the company’s 2016 results. As Warren gave his opening remarks, Bogle couldn’t help wondering why Galbraith had brought him to Omaha.
Then Buffett started to talk about Bogle. Buffet began saying, “Jack Bogle has done probably more for the American investor than any man in the country.” He then asked Bogle to stand to a wave of applause from the audience. Buffett explained Bogle’s prominent role in pioneering index-fund investing. He lauded Bogle for being “the greatest friend of American investors” helping to put “tens, and tens, and tens, of billions” into the pockets of investors.
Index Funds
While Bogle isn’t all that close to Buffett, they enjoy a positive relationship. Buffett is a strong advocate of index funds. As a matter of fact, he famously used an index fund to bet against actively managed funds, coming out of the crash in 2008. Buffett chose Vanguard’s S&P500 fund, while the hedge fund guys chose the best hedge fund managers to prove that active investing delivered superior results. Needless to say, Buffett won the bet hands down. He then took his $3 million in winnings to a local charity.
Buffett has directed the trustee of his wife’s estate to put 90% of the trust into the Vanguard 500 Index Fund and the remaining 10% into short-term governments. That’s a tribute to index funds that money just can’t buy.
Bogle credits his founding of America’s first index fund to Paul Samuelson. Paul Samuelson is a Nobel Prize-winning economist who wrote a paper called “Challenge to Judgment”, emphasizing the merits of index funds over active investing. Bogle responded to his challenge by starting the world’s first index fund. Years later, Samuelson ranked Bogle’s index fund invention “along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese”. Samuelson also adds that though it never made Bogle rich, it “elevated the long-term returns of mutual fund owners. Something new under the sun.”
Lower Index Fund Fees Can Strongly Boost Returns
Bogle notes that mutual fund fees are now about 70 basis points (100 basis points equal one percentage point) on average. Applied across an $18 trillion industry, that’s $126 billion in fees alone. That is a staggering amount of money for funds that rarely beat the index. By comparison, index fund investors pay only about 4 basis points, or 4 100ths of 1 percent, and reinvest their savings.
Compound that over 50 years. Index fund investors will end up with earnings that are 3 times more than those who invest in active strategies. Imagine that!—retiring with $1.5 million if you went with index funds, versus $500,000 if you tried active investment strategies. You get more than 3 times as much capital just by getting cost out of the equation.
As Bogle says, “If we could get that message across to everybody, we’d get a real revolution.”
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.
Steve Pomeranz: I think you all know my next guest. He is Jack Bogle, the founder of the Vanguard Group and the creator of Vanguard S&P500 Index Fund, which was the very first S&P500 Index Mutual Fund in the world, I suppose. You may also know that Jack speaks out as an advocate for the average investor. He’s author of numerous books and the recipient of many prestigious awards. As a matter of fact, in 2004, Time Magazine named him one of the world’s 100 most powerful and influential people. And it’s a pleasure for me to have Jack Bogle with me today. Hi Jack, welcome to the show.
Jack Bogle: Thank you, Steve. It’s always good to be with you.
Steve Pomeranz: Thank you. You know, we’ve been doing a series about Warren Buffet, in light of the recent Berkshire annual shareholders meeting in Omaha. We interviewed Lawrence Cunningham, the author of The Warren Buffett Shareholder, in which you wrote a short piece about your experience in 2017. Please share with us that experience.
Jack Bogle: Well, it was really a great thrill and a great surprise. And my friend Steve Galbraith, a money manager from New England, told me to save the date, the day before my birthday last year. And I didn’t know what he wanted. I did save the date. He pulls up in a Cessna Citation and flies me out to Omaha. And he said we’re going to Warren’s annual meeting. And so we had a nice time. Our wives were with us and some of my family members were there. And I still didn’t know what to expect.
So I’m sitting in the audience right at the beginning of Warren’s background recap of his year. And he starts to talk about me. And he says, “Jack Bogle has done probably more for the American investor than any man in the country. Jack, will you stand up?” And I did stand up. And there was this wave of applause. I don’t think many people get that. And I think in Larry’s book, I’m probably the only one who wrote a piece about being, getting a shout-out from Warren. It was quite long. And wonderfully rewarding. And surprising to my wife. But it was just a delightful way to be there and to get a little recognition. He also wants to put up a statue for me, as being the greatest friend of the American investors.
So Warren and I have had, not a close, but very positive relationship for, probably 20 years—actually, about 30 years. And when I first met him in a hotel in San Diego, California, when we were both speaking to a convention group, and we go back and forth with letters, he’s endorsed my books. And he’s endorsed indexing, index investing, over and over and over again in, I think, eight of his annual reports. Maybe a few less than that. And so we have a lot in common. And the index fund is his recommendation to almost any investor who asks him, “What should I do if I don’t buy Berkshire Hathaway?”
Steve Pomeranz: Right, yeah. Well, you know, he’s been recommending index funds since 1996. And he famously used the index fund as a bet against a hedge fund, coming out of the crash in 08, betting that the index fund would do better. And I don’t know if you’ve seen the numbers; I surely have seen the numbers. And the S&P500 walloped that hedge fund. It was actually pretty pathetic. It was actually a fund of funds. So supposedly the hedge fund was hiring the best hedge fund managers and putting them all together and weeding them out and putting others in and so on. And even with all that, they couldn’t even come close to a simple S&P500. So he won the bet. And about $3 million went to a local charity, which was pretty terrific.
Jack Bogle: Well, that’s what he did. And it’s interesting your choice of the way he hired the best hedge fund managers. The rival did. But the reality is, the best is always looked at backward. Who did best last year, last 10 years, last 15 years. And it doesn’t repeat itself. So that failure was really to be expected. I was rooting, of course, with Warren every step of the way. And then the bet came in just about the time of the annual meeting last year. And actually, one of the participants at a dinner I went to, was the loser in that bet. So, it’s an interesting way for Warren to show his confidence.
Even more interesting, Steve, is that he has directed the trustee of his wife’s estate to put 90% of the trust essentially into Vanguard 500 Index Fund. And 10% into short-term governments. And so that’s a tribute that money can’t buy.
Steve Pomeranz: Let’s go back to the beginning a little bit. I read that the professor, the American economist Paul Samuelson had a strong influence on you at the very beginning. What was he writing about? He eventually won a Nobel Prize for it. What was he writing about and what was he finding in his data that led you to create the S&P500 fund?
Jack Bogle: Well, he was the guy, I actually had been talking about an index fund, believe it or not, Steve, since my Princeton University thesis in 1951, where I said mutual funds can make no claim to superiority over the market indexes. So, it was not a new subject for me. But Paul Samuelson was the precipitating force that made me act when I did act. We had just started Vanguard in September, started on September 26, 1994.
About two weeks later, I opened the pages of the journal of portfolio management and there is an article called “Challenge to Judgment,” by Paul Samuelson. And in that challenge, he says, “Show me the brute evidence”, was his phrase, “that an active manager can beat an index fund. And no one has yet shown me that brute evidence. We have thought about an index fund, starting one by professors, but we don’t have the resources to do it. So I hope somebody, someday will start an index fund. And here’s this new company Vanguard, a mutual company looking not to make money for its managers, but to make money for its shareholders.”
And it was like, for the want of a better expression, Steve, manna from heaven. I started thinking about it very heavily then. And within a year, had gotten approval of the board of directors to do it. Basically, our first position as a new company called Vanguard.
Steve Pomeranz: You know, I know that he wrote later, and I have a quote from him. He says, “I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese. A mutual fund that never made Bogle rich, but elevated the long-term returns of mutual fund owners. Something new under the sun.”
Now, you know, the Gutenberg printing, the wheel, the alphabet. But I think the wine and cheese portion of that is probably the greatest gift.
Jack Bogle: Well, that may be the greatest gift, but it’s probably the fairest comparison too, Steve.
Steve Pomeranz: Why’s that?
Jack Bogle: Well, I’m not doing better than Mr. Gutenberg.
Steve Pomeranz: Sure. Sure. Oh, I see. So wine and cheese is a another level.
Jack Bogle: We got those citations of his, basically the world is changing. And in the case of Vanguard and the index fund, we changed the world of finance, but not the world.
Steve Pomeranz: I want to get into that. I want to start talking about, specifically, what is operating here and the idea of these index funds, versus the standard mutual funds. Actively managed funds versus what we call passively managed funds. So, let’s start with fees. I know that’s a big part of it. There’s a lot of pressure on fees in mutual funds these days. Pressure for them to go down, which is a good thing. And it was mostly started by your company’s relentless drive to lower fees in the index funds and then see that index funds are really outperforming these higher fee mutual funds. You wrote that the average expense ratio in 1960 was .48%. And by the way, expense ratio is that amount that you’re paying inside the fund, that if you look closely, you’ll see it’s a percentage of assets.
So in 1960 it was .48, whereas now it stands at more than twice that amount, at .98%. So I’m a little confused because I see mutual fund fees coming down. What is actually happening with the cost of mutual funds? Are they rising still? Or are they falling?
Jack Bogle: That’s a good question and a fair question, Steve. Number one, they did drop in the early years to something around 50 basis points, .48, .46. And they’re now, in fairness, about .70, they’ve come down a little bit in recent years as the funds have grown. So, what’s happened is that while the market has carried these assets upward of mutual funds, the managers have not shared the economies of scale with the investors. Just think about this. I can’t do the math in my head, but apply a 50-basis point fee to a $5 billion industry. And then apply a 70-basis point fee to an $18 trillion industry. The dollar amount of the fees is staggering. And very few of those economies of scale have been shared with the fund investors who created them in the first place.
Steve Pomeranz: Yeah, you know, in today’s world, if you think about Amazon and you think about these very thin margins and they’re looking to create tremendous volume in order to earn their living. Mutual funds, for some reason, I think we can compare the index fund to Amazon in that regard. Lowering the cost, passing through the savings of greater assets under management to the shareholder of Vanguard funds and other funds as well. But, you’re saying that these mutual fund companies are keeping the difference for themselves?
Jack Bogle: That is correct. They often have a—40 of those 50 largest fund complexes actually are owned by international conglomerates or US conglomerates, and they buy those companies, the fund companies, to earn more money for their own shareholders. They want a return on their capital. They’d like to get a return on the shareholders’ capital too, but those two objectives, making money for ourselves and making money for our clients, are directly conflicting.
Steve Pomeranz: So, basically, it’s up to the individual investor to awaken and understand what is actually going on and work with an advisor who understands that as well and strives to put his or her clients in those kinds of low-cost investments. You know, Wall Street is a sales-driven entity. It’s all really about profits. There’s no doubt about that. Today we see a proliferation of new products claiming to get better returns than simple indexing. So now I want to switch gears a little bit because way back when we had active managers, individuals, or teams who tried to beat the markets. Now we have big data and perhaps in the future, AI, which pretends or portends to be better than simple indexing.
So my question is, these are called smart data funds. What is smart data and what are your thoughts on these new inventions?
Jack Bogle: Well, smart data is described by William Sharp, the Nobel Laureate from Stanford as stupid. There is no smart data. There’s a reality in all this, Steve, and that is, for all investors as a group, there is a market return out there. When all those investors get together, they’re going to get the index return collectively because they own the index, these hundreds of thousands of investors or millions of investors. And so, they’re going to pay about 2% a year for that privilege. And the index investor is going to pay about four basis points, four one-hundredths of one percent for that privilege. So guess who’s going to win?
Steve Pomeranz: Just by that very factor alone.
Jack Bogle: Yeah. And think of the dimension of it for an investor. Let’s assume an investor in the lifetime of 50 years of investing and most of them will be much longer than that, in this age of extended mortality tables and that kind of thing. And if you invest for 50 years at 7%, let’s assume, you’ll earn about $30, $32 on each dollar you put in. Amazing. And if you invest and get 5%, that would be the 7 minus the 2, you’ll get about $10. So you get more than three times as much capital, just by getting cost out of the equation. If we could get that message across to everybody, we’d get a real revolution.
Steve Pomeranz: So, it’s this magic of compounding, which is so important for people really to understand, is the way the capital expands after so many years. You know, if Warren Buffett is worth $70 billion today, and he earns a 7% rate of return, Berkshire does and he has his shares, he’s going to be worth $140 billion in 10 years.
Jack Bogle: That is correct.
Steve Pomeranz: And it’s very simple math. It’s this law of compounding. That’s why really the big returns will come later in life, but you’ve got to stick with it early on. And let’s get to the difficulty of sticking with it, Jack. And by the way, my guest is Jack Bogle, the founder of the Vanguard Group and creator of the Vanguard S&P500 fund.
Let’s talk about the individual investor and their propensity to do exactly the wrong thing at the wrong time. They want to buy when the markets are up—especially if it’s at an all-time high and getting exciting—they’re bearish when the market is at an all-time low and they want to sell. Well, you know, that’s a sure way to lose money. You know, I’m an investment advisor and I see this every day. I work hard to convince people to do the opposite of what they want to do in tough times. Do you, first of all, do you think there is a role for a fiduciary investment intermediary who is going to increase the cost of investing, but perhaps enable clients to succeed at it in the long run?
Jack Bogle: Well, let me say a couple things. Let me start by talking about compounding because I wanted to have a comment on that. And that is, what I say is, enjoy the miracle of compounding long-term returns without the tyranny of compounding long-terms costs. There’s a double compounding, one of which helps you enormously, one of which hurts you enormously.
Now when you come to the role of the financial advisor, the question you just asked, I…of course, there’s a role for a financial advisor. Now, it requires him to be very knowledgeable about the business. Sure you appreciate the role of cost and focus on low-cost funds that he offers to his clientele. And aware that, as Morning Star has said, they have a very sophisticated performance rating system for funds. They have candidly said that you will do better than their performance rating system at Morning Star if you just buy the lowest cost funds. That’s a pretty good concession.
Steve Pomeranz: As far as Morning Star, yeah.
Jack Bogle: Now you want very low costs in index funds. There’s also reasonable way to look at actively managed funds. And think about them in terms of their costs. And by costs, I mean not only their expense ratios, which are very easy to measure and compare, but also their portfolio turnover. It’s a very high hidden cost. And if you go with funds with lower portfolio turnover as well as low-expense ratio, you will do much better. An advisor should be aware of all this. And I’m sure the best advisors are.
They would also be well advised, I think, but every time someone comes in and says, “See how well this fund has done, it beat the index by a lot.”, and I’m sure advisors hear that, and maybe even say that. They should remember that the past is not prolonged and that there’s a lot of reversion to the mean. That’s the key in this business. Where the good funds turn out to be bad, the bad funds turn out to be good.
That brings me to your question about investor behavior. And investor behavior is really quite bad in the mutual fund industry, that’s the only measure we have. And it looks as though, and Morning Star measures this, and it looks as though the returns reported by the mutual funds are reduced by about one and a half percent a year, or two percent a year, by the returns for the investors that investors actually earned.
So fund investors minus two percent compared to what you receive from the funds is a huge loss. And the reasons are pretty much what you say, a little bit different. I mean, certainly acting at market highs when optimism is high. You’re optimistic and you buy, of course. And the reverse when markets are low. But it goes over in the mutual fund business. The buying funds that have done very well in the past. And it’s amazing how they don’t repeat. We should not … I don’t want to go too far here, but if we didn’t allow the people to … if we didn’t allow the production of past-performance records, we would be a lot better off in this industry. That’s not going to happen.
Steve Pomeranz: That’s not going to happen. You’re right. My guest, Jack Bogle, Founder of the Vanguard Group, creator of the Vanguard S&P500 fund and outspoken critic of Wall Street but also advocate of the average investor. Jack, thank you for spending your precious time with us today. Thank you so much.
Jack Bogle: My pleasure Steve. Good to be with you.
Steve Pomeranz: All right sir. Thank you very much. I appreciate it.
Jack Bogle: Are we okay?
Steve Pomeranz: Yeah, we’re okay.
So, it was fun talking with Jack Bogle. If you have a question about what we just discussed, ask us. Go to StevePomeranz.com. Ask us anything you’d like. That’s StevePomeranz.com. And while you’re there, sign up for our weekly update where we will send you the weekly commentaries and interviews straight to your inbox.
