The transcript from this week’s MIB: Remembering Jack Bogle, is below.
You can stream/download the full conversation, including the podcast extras, or download it on Apple iTunes, Overcast& Bloomberg, Stitcher. Our earlier podcasts can all be found at iTunes, Stitcher, Overcast, and Bloomberg.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: I know I say this every week that I have a very special guest, but this week, I really have an extra, very special guest. His name is Jack Bogle and he is the founder of the Vanguard Group and the inventor of the index fund.
Did I oversell that this is a special guest or not? Let me tell you a little bit about how this date came about and what made this so interesting and weird and unusual. First, I’ve been chasing Jack Bogle for literally years and he doesn’t travel much, he is a homebody, he lives near the Vanguard headquarters, he’s not much for coming into Manhattan and recording something like this, but we did the interview with chairman of Vanguard, Jack Brennan about a year and — to almost 2 years ago and that went really well.
And then last year, we did — just about a year ago, we did the interview with Bill McNabb, he is the current CEO of Vanguard Group and I started poking and prodding and asking “Hey, when can I sit down with Jack? When can I sit down with Jack?” and finally I just said, we’re willing to come to Pennsylvania and meet with you guys, and they said “Oh, if that’s the case, come on down.”
So you’ll hear when we sit and talk with Jack, this was not the usual interview partly because he’s just a force of nature and I try and balance between guiding the conversation to the specific questions we have and keeping us on track to cover a variety of topics and subjects and you can pretty much tell when I give up about three or four questions in and just say “Jack Bogle is a force of nature” I’m just going to have a conversation with him and let it go.
A little background on the day, this was a couple of Thursdays ago and we basically left the New York area ungodly early, I want to say about 4:30 quarter to five, drove down to Pennsylvania actually, we left so early we beat all the traffic not only around New York, we got there before the traffic from Philadelphia. So I had my first Cracker Barrel experience having breakfast at a Cracker Barrel which apparently is very common outside of downstate New York, it was quite delicious, we get to the Vanguard campus about an hour early, spent some time in their galley, get it? Vanguard, it’s the staff or crew, the cafeteria is a galley, it’s got all these nautical themes and were finally ushered into a small conference room off of Jack’s office.
And he’s — you’ll hear during the interview, he’s 86 years old, he is sharp as a tack, smart as a whip, his voice is still very strong very powerful and any pretense I had of following a script and trying to ask specific questions pretty much went out the window.
So you’ll hear me wrestling in the beginning, some of the questions you’ll hear me trying to keep him on our original script, then and I — you know, 10 minutes into this conversation, it’s pretty clear, hey this is a bucking bronco, just try not to get kicked in the head, keep feeding him questions based on wherever he goes just follow him and take it to where it goes, and all told, I thought this was really a fascinating conversation.
He sat with us for 90 minutes, he was supposed to go to lunch with someone else. I’m pointing to my watch, he is waving me off like him tell them not to steal home, and he’s coming in, he doesn’t care, and so it ran a little long, by the time we back out some of the other stuff you’ll hear, this is a substantive lengthy conversation.
If you are at all a Vanguard fan, a Boglehead, an index fan, you are going to have a field day with this. I had to set this up because really it was such an exciting experience for me to spend 90 minutes with the man, the legend, here it is, my conversation with the one, the only, Jack Bogle.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: I know I say this every week that I have a special guest, but this week I have a super special guest, the one, the only, Jack Bogle, founder and chairman emeritus of the Vanguard Group, essentially the creator of the word holds first index mutual fund for individuals in 1975.
I could read your CV, which will essentially take up the entire show, there’s so much stuff to talk about with you, you are a legend in the industry and maybe the person who has had the single biggest impact on investing of anyone, but let’s just start from that beginning undergraduate thesis.
You’re in college in Princeton in 1950, 1951, and you’re thinking about why do actively managed funds — why do so many of them underperform the market? How did that come about for a college student?
JACK BOGLE, FOUNDER AND CHAIRMAN EMERITUS, VANGUARD GROUP: Well, it came about by great accident and that is I was majoring in economics, I was looking for a subject for my senior thesis, which is a requirement still at Princeton, extensive document, mine turned out to be maybe 135-40 pages and I didn’t know what to write about, but I wanted to write about something that no one had written about before.
And there in December 1949, I was reading Fortune Magazine which I did as part of economics background just voluntarily, and there was an article called “Big Money In Boston” and it was about the mutual fund industry and described this tiny industry and maybe $2.5 billion for the industry as tiny but contentious, and I thought, well, you know, I’m kind of tiny and I’m kind of contentious, so I will write about it.
And I wrote the thesis, enabled me to graduate with high honors from Princeton, very — pretty good job, not a great thesis but not bad for somebody a year out of his teens.
RITHOLTZ: Let me let me a push back at you and say that was an incredibly insightful thesis, the insight that you derived at a very young age is the cost of all this active management, they were unable to overcome that bogey even to today what should really be so obvious to everybody, lots of folks still haven’t seem to figure that out.
So what makes me stop and pause and ask you this question, how did you ever come to that conclusion at such a young age without the universe of information we have available to us today?
BOGLE: Well, to begin with, the thesis’ title was “The Economic Role Of The Investment Company” and the overall or the overriding focus of that thesis was mutual funds are there to serve investors, put the investors first, I talked about reducing sales loads, reducing management fees, focusing on investing and not marketing, things of that nature, and that’s what the industry in my formula would have to do to reach its great potential.
And I did not, actually, to be very clear on this, I did not assemble any data but I looked at about 15 leading mutual funds and looked at their records and without adding and dividing and getting averages, it was very clear that very few of them, if any, at that time could outperform the S&P 500 index.
So it was basically anecdotal, although this industry in those days was very much a commodity in a way, kind of the major funds of those days were just basic — basically buying a long list of blue-chip stocks, you could call them Dow Jones industrial average funds, were later because the S&P wasn’t very well known then, you could call them Standard & Poor’s kind of thoughts.
They were down the middle. They had fluctuations, very similar volatility, very similar to the index.
RITHOLTZ: So even back in the late 40s early 50s, mutual funds were closet indexers?
BOGLE: Sure, absolutely.
RITHOLTZ: That’s quite fascinating.
So let’s fast-forward a little bit. So now you’re working as Chairman of Wellington Management Company and long story short, you said the most unwise decision of your career you do a merger, doesn’t work out, and they end up breaking it down from lieutenant to private so to speak.
BOGLE: Less than private.
RITHOLTZ: Less than private and you wanted to run a fund and they said well you know because of this M&A, we don’t want you running an active fund, if you want to put together — how did the index come out of that job change?
BOGLE: Okay will let me say my first job and that was 35 years old, and Mr. Morgan the founder of — Walter L Morgan, the founder of Wellington, called me into his office, Wellington was in trouble, Wellington fund was in trouble, its performance was slipping and Wellington Management Company was in trouble because we were basically a one product, if you will, company, a conservative balanced fund. We were for the one of a better metaphor, the bagel of the mutual fund industry. The hard, not sweet, nutritious, safe choice in the biggest balance fund in the industry and people stopped buying bagels and started buying, if you will, doughnuts. We came in to the go-go era, and all these fancy growth funds, high-powered, buying stocks that had no investment — no intrinsic invest merit at all…
RITHOLTZ: This is the mid to late 60s, the nifty 50 and that sort of…
BOGLE: This was the go-go era.
RITHOLTZ: Yes.
BOGLE: And the go-gos came and the go-gos went, but if you’re in the bagel business and nobody is buying bagels, and this was a balanced fund, share of industry sales actually dropped to 1 percent.
RITHOLTZ: Wow…
BOGLE: And so I had to do something and Mr. Morgan told me “do it.” and I talked to a couple of firms about merging and then I came across this firm in Boston and had a fund will Ivest fund, one of the go-go funds of the day, they had some apparently bright young managers that I had kind of common cause with, and they had a pension business, so we got the new managers that would save Wellington fund. We got the go-go fund that we needed to stay in business, then we got into a new business that we thought we could be very successful in. It was from the words of one syllable, two syllables, Bridget (ph).
RITHOLTZ: I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio. My extra special guest today is Jack Bogle, he is the founder of Vanguard Group and essentially the inventor of the index fund.
Jack, we were speaking earlier about how a crisis at Wellington which was the predecessor you worked at to the Vanguard Group actually led to the creation of the Vanguard Group. Tell us how that came about?
BOGLE: Okay, well, let’s start with the fact that in doing this merger which I was eager to do, I gave up too many votes in the company and so when everything fell apart, the market went down and so on, right — so the market was going down in 1974, it would be a 50 percent decline, the happy partners fragmented and there were four of them and there was one of me…
RITHOLTZ: Right.
BOGLE: And they had packed the board of directors, they were very political and they fired me, the guys that had caused this catastrophe fired the one that was trying to avoid it and so I was out of the job. So what could I do? I could go try and work for another firm, I had a young family living here, I didn’t want to move, I was very angry about what happened of course but you know, what is is, so I decided my best chance was to talk to the directors of the Wellington Fund, this fund so badly hurt, the – the diamond in our crown and say look, at the management company has fired me, but you, you’re a slightly different group, can keep me and we will tell the management company what to do.
We will be in charge of the administration of the fund, anything necessary to make it work, and we will be in charge of appraising the advisor and taking whatever steps we want, we will be independent of the advisor, and I wanted to take over distribution too, but the directors wouldn’t go along with that.
So we became a little administrative company and I wanted a glamorous name, so I founded the name Vanguard, when I first learned about — as we go from Wellington, the land battles of the Napoleonic wars, the Duke of Wellington, the naval battles of the Napoleonic war, and there’s Lord Nelson at the Battle of the Nile, one of the most complete the most complete naval victory in history to this day, and he writes of this dispatch that I see from the deck of HMS Vanguard, his flagship.
RITHOLTZ: And that sounds like a great name for a company.
BOGLE: Perfect, perfect.
RITHOLTZ: From Wellington Fund, how did you actually form the Vanguard Group?
BOGLE: Well, the idea was that the funds would create a new company that they owned they would capitalize — capitalization was very small, I would guess maybe $250,000, it’s is a very small company at that point. Actually, the total assets of the funds were down at around 1.5 billion. So we capitalized the fund and Wellington management company had to take it because the directors of the funds were in charge of the contracts with Wellington.
RITHOLTZ: So you really backdoored your way back into the company after they had fired you as chairman?
BOGLE: Yes, I think that’s a fair statement, but from a technical standpoint, I’ve been the chairman of the Wellington Fund all along.
RITHOLTZ: Got you.
BOGLE: So I had the same old continuity that I had going back to 19…
RITHOLTZ: Just post merger, this was a backdoor, so how do you go from that to the Vanguard Group?
BOGLE: Well, we put a name in the company because we had I think in those days maybe a dozen funds, we didn’t want a dozen separate companies to manage it…
RITHOLTZ: Right.
BOGLE: So we had to have a core central company and that that would pool resources of all the funds and provide all the services, and we had allocation methods between the funds and that was all good until we decided to take over distribution which was our — let me, I’m a little bit ahead of myself, let me go back and say to — the first thing, we were not allowed to go into the business of investment management, that was theirs, we were not allowed to go into the business, that was theirs painfully (ph), that was theirs meaning Wellington.
RITHOLTZ: So the active side, you couldn’t do.
BOGLE: And we couldn’t go into management, we didn’t distinguish between active and passive.
RITHOLTZ: Oh really?
BOGLE: And in those days, not in those days, there weren’t any index fund.
RITHOLTZ: Right, so if you couldn’t go into management, how were you able to set up the Vanguard 500?
BOGLE: Well, be patient.
RITHOLTZ: Okay.
BOGLE: So, we were not allowed to go into distribution because that was Wellington’s function, too.
So we had this little administrative company looking over however the legal responsibility and the board responsibility to look over the advisor and distributor. So we were in charge and so my first — I knew a company that was administrative company was not going to be anything for me.
I mean I like the administration, I know how well it has to be done shareholder record-keeping and all that, but that’s just not the a challenge I was looking for, and any company that’s going to succeed is going to have to control the kind of funds he wants to — they want to run, the kind of distribution they want to have, who will buy the funds? Who will sell them, things of that nature.
So we have a company that’s just in this little administrative box and I’m thinking let’s do something. So at the very first board meeting of the new company after we have gotten organized, I say we got to start an index fund, and the director say you’re not allowed to get new investment management.
And I say this fund isn’t managed and believe it or not, they bought it.
RITHOLTZ: So in other words, you described the index fund as just hey, it’s the 500 largest companies in America, there’s no manager, nobody’s in charge, it’s just — it is an unmanaged broad index and they said “Oh go do that.”
BOGLE: They said, well, I won’t say it was that easy, but that was the final decision.
RITHOLTZ: I get the sense from what you’ve described that they were kind of, “Let’s let Jack do that, he will be out of our hair, it will keep him busy and fine, won’t cause anybody trouble.”
BOGLE: I think you’re pretty much on the mark.
RITHOLTZ: This week on Masters in Business on Bloomberg Radio, I have an extra special guest, his name is Jack Bogle, he is the founder of the Vanguard Group, the inventor of the index funds and author of far too many books to mention, I’ve been speaking with Jack here in the headquarters of Vanguard and just outside the conference room we were sitting, on the wall is a framed print and on that print, it says, “stamp out index funds.” Jack, what on earth does that mean?
BOGLE: That means Wall Street couldn’t make any money out of index funds and so Wall Street didn’t like it, we had initial public offering, I went all over New York so many times to try and find underwriters and finally got the four largest retail underwriters, Paige, Dean, Witter, Reynolds, forget to the other one was…
RITHOLTZ: Paige, Dean, Witter, Reynolds. Okay.
BOGLE: They were the biggest guys in the business, and they said we can do $150 million for this great new idea. They did $11 million.
RITHOLTZ: So less than 10 percent.
BOGLE: And they came in to see me when the underwriting was over and said, I said to them “look, we can’t even buy around lots of all 500 stocks.”
RITHOLTZ: Right.
BOGLE: And they said, “Well, why don’t we just give everybody their money back and pull it?” I said, “Are you kidding me? We have the world’s first index fund.” and it’s the world first index fund period. You have to say retail to a lot of institutional holdings at the beginning, it’s the world’s first index mutual fund, no question about that. And the…
RITHOLTZ: Amazing.
BOGLE: And so it got — it went nowhere fast.
RITHOLTZ: $11 million launch, what year was that?
BOGLE: That was in 1976.
RITHOLTZ: Right, $11 million and everybody laughed and nobody thought there was any future to index funds.
BOGLE: That’s exactly right.
RITHOLTZ: That’s just astonishing. Well you had incredible foresight to say and it makes sense that the four largest retail shops would want to participate in this because this is a simple easy way for their retail client to get exposure to the market fast, easy, relatively inexpensive.
BOGLE: It should have except when the client buys this fund, it’s to be held forever, they don’t trade it and the fund doesn’t do any trading, there’s no brokerage business generated by the fund, so this was not a happy moment for Wall Street and they looked at it, I think, as some kind of the beginning of a communicable disease.
RITHOLTZ: Right.
BOGLE: And it had to be stamped out. The Center for Disease Control had to come in.
RITHOLTZ: Did they really perceive you as a threat or did they kind of laughed it off and “Yes, yes, best of luck with that Jack.”
BOGLE: Yes, I’d say pretty much that way although we did a couple years ago for one of the funds anniversaries, we all got together with the underwriters.
RITHOLTZ: All four underwriters.
BOGLE: All four underwriters and their lawyers and our lawyer — lawyer singular, we only had one in those days and they’re all good people, you know, I don’t — and we all do our best in this life in very different ways at work. So it worked out well, it had to start and it did start.
RITHOLTZ: So here’s the question that I could ask you 40+ years later, Vanguard is now running three point something trillion dollars, 4 trillion is not that far off in the distance, an enormous success, one of the single largest asset managers in the world, how come nobody ever said “hey those guys are onto something, we should be a competitor to them.” how did that never come up anywhere along the lines?
BOGLE: Well the answer is so simple. Index funds have a real problem, all the damn money goes to the investors.
RITHOLTZ: Right.
BOGLE: Managers can’t take anything, they are not managing.
RITHOLTZ: Well, but you are taking 10 or 15 basis points and on trillions of dollars, that’s not nothing.
BOGLE: Well, nobody expected to get to trillions of dollars believe, not at 11 million.
RITHOLTZ: But, okay, in ’74 or ’76, it’s 11 million, but by the time you get to the mid-1990s, you’re hundreds of billions of dollars and then I think you hit 1 trillion was it late ’90s? So even ’97, ’98, ’99, didn’t anybody say “Hey those guys in Pennsylvania, they have $1 trillion, why don’t we do what they’re doing?”
BOGLE: Well, it’s a problem and eventually the big guys had to, Fidelity had to have, they were dragged kicking and screaming in indexing and they have to be competitive on price, they can still make all the money they want and it’s an awful lot on the actively managed funds, so it’s kind of a loss leader for Fidelity.
RITHOLTZ: And what about others? Blackrock and American Century and all these other entities, Schwab offers an index, it seems everybody offers some version of the S&P 500 index.
BOGLE: Yes, well, T. Rowe Price a good example, they have a hidden index fund, they don’t talk much about it, it’s kind of expensive, 20-25 basis points relative to our five and it’s a kind of a side ball thing so they can get into the retirement market. This has become a marketing business and right now, we’re seeing this tremendous change in people for realizing the importance of low-cost and a long-term focus, and if you just keep those two things in mind, you will never do anything but own a broad market index and hold it forever.
RITHOLTZ: I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio. My extra special guest this week is Jack Bogle, he is the founder of the Vanguard Group, inventor of the index funds, author of numerous books, let’s jump right back into the issue of costs and how they impact investors. You’re known as the person who created the index fund, but really which do you think is more important? The passive indexing or the fact that it’s so low cost?
BOGLE: Well and it’s pretty clear to me that passive indexing is the more important because I’m going to define cost in a couple of different ways here.
RITHOLTZ: Okay.
BOGLE: One is the expense ratio and our funds — the index funds probably average about 10 basis points, our managed funds probably average about 35 so there’s not that big a difference, the industry is up around 120 on an unweighted basis.
RITHOLTZ: And when we talk about basis points, a basis point is just a percentage of — so 100 basis points is 1 percent, 10 basis points is 1/10 of 1 percent, if you’re averaging 10 basis points, that’s a very, very inexpensive.
BOGLE: It’s five/100 to 1 percent.
RITHOLTZ: Five basis points, five/100ths of 1 percent, that’s very inexpensive.
BOGLE: That is really inexpensive but that’s because we have a mutual company owned by its shareholders that don’t have to deliver profits and think about this for a minute Barry, that the profit margins in this business can easily run to be 50 percent. So if you got a 1 percent expense ratio, you’re making 50 basis points on the top. So you’re actually operating at 50 which is probably not too bad because very few people have the scale that we have developed.
RITHOLTZ: Sure.
BOGLE: Have the technology that we’ve developed, have the efficiencies that we developed. And also I don’t think this is self-serving, have the bully pulpit that we have. You know, imagine Fidelity coming into this business, described — I described that as dragged kicking and screaming to the business. So here we have kicking and screaming over here, and here we have missionary zeal, the bully pulpit, by — this is the way, this is the new way.
RITHOLTZ: And you have all entire universe of evangelists amongst the adviser community who have drunk the Kool-Aid and say, “hey low-cost indexing is the way to go” following the financial crisis it seems like Vanguard was sucking up all the money in the room and everybody else was an also run — also-ran, are events like the great financial crisis, does that sort of shake people out of their false belief and send them in the direction of “hey, these missionaries, turns out these guys are right.”
BOGLE: Well and you’re certainly right in a sense, it’s not easy to read but what happens when the market goes way down and went down — roughly 50 percent in 2007 to 2009 and all these managers that says we will manage your money for you, the shareholders kind of led to expect they will anticipate this and not let it happen to them, they may not directly communicate that but if someone says “Well, I’m pretty smart, I’m a smart manager” you would expect that the down-market, they would do a good bit better than the market.
Well of course, to begin with, they can’t, because some do and some don’t and they are all averaged together.
RITHOLTZ: And how are you picking one over the other? You never know in advance, you can only guess and what good is that?
BOGLE: Yes, exactly, so the down markets do help that, but it’s also this wave of — you know, there’s not an economics course, there’s not an MBA course, and in investing or finance that doesn’t say basically indexing is the way. It’s the data that matters, it’s the data, and it’s going to so instead of — usually if you look back and see a fund that’s done well, you can pretty much conclude it will not do well in the future, everything reverts to the mean.
RITHOLTZ: Right.
BOGLE: The index does not, it continues to give you your share of the market return and when you look at the numbers, one of my favorite constructions is it the index fund gives you the advantage of long-term compounding of returns while eliminating the tyranny of a long-term compounding of costs.
So think about it this way, let’s assume the stock market gives a 7 percent return over your life — over 30 years for over 50 years, if you get the 7 percent, each dollar goes up three times, if you get 5 percent, that would be 7 percent less the industry’s typical 2 percent all in cost, you get $10.
RITHOLTZ: Wow.
BOGLE: So $10 versus $30.
RITHOLTZ: Huge difference.
BOGLE: So you put up 100 percent of the capital, you took the hundred percent of the risk and you got 33 percent of the return. And as I say to people, if that strikes you as a good deal, by all means, do it.
RITHOLTZ: So Morningstar once famously did a study which I’m sure to this day, they regret, and the study that they became famous for their star rankings of mutual funds and I’ve written about this, you could Google this, people can find this, someone internally did a study and said, if you don’t have access to Morningstar data but you just looked at a single data point across the universe of mutual funds, what would be the most helpful? Would it be the track record? Would it be the manager? Would it — and it turned out that if you forgot about everything else and only picked the lowest-cost funds, that generated the highest returns going forward.
So how — that makes me ask the question, how important are keeping costs low to investors.
Well, when you give the statement that it’s only cost that matters, I’m inclined to say as the kids would say, Barry, “duh!”
RITHOLTZ: It seems obvious after the fact but for the longest periods of time, people — so let’s — let me digress and talk a little bit about hedge funds. While all this money is flowing to Vanguard over the past decade since the financial crisis, you guys went from 1 trillion to over 3 trillion, the other segment of the market that attracted a ton of money was the hedge fund industry, which charges 2 percent, forget five basis points 2 percent of the assets under management +20 percent of the profits, and they also scaled up across 10,000 funds to $3 trillion. How do you explain despite the obvious “Duh” how do you explain so much money flowing to a group with such high expenses?
BOGLE: Well, greed, the buyers greed and perhaps even the managers greed because those are very high costs, but people are looking for a better way. It’s pretty easy, I’ve done a lot of work on this, you may have read some of it to forecast what the stock market return is going to be within reasonable magnitudes over time, not in a year-by-year but over decades. And so you know where you are going to be roughly in the stock market and you say a pension plan — pension plans are a very heavy part of the of the hedge fund business because they don’t have to worry about the high taxes generated by hedge funds.
And so they say we got to have more and someone comes and shows them their past record and guess what, they put the S&P 500 to shame. Of course, they wouldn’t show you the record if they didn’t. So…
RITHOLTZ: A little survivorship bias built into that?
BOGLE: Sure, well, there is survivorship bias built into it but most of all, theirs — it ignores the fact of life in this business, it’s everywhere, reversion to the mean, biblically put, Barry, the last shall be first and the first shall be last. And it happens to hedge funds, it happens to mutual funds, it is basically a fundamental law.
RITHOLTZ: Seven fat years, seven lean years, and there is no way around it.
BOGLE: Yes, the number of years may differ but you got it.
RITHOLTZ: All right, well, you referenced the Bible and that phrase that always stayed with me. So let’s stick with the issue of indexing for now, and I want to quote something that Charlie Ellis had wrote, Charlie was not only on the board of the Vanguard Group Board of Directors but he was also an advisor to the Yale Endowment Fund and he wrote a wonderful book called winning the loser’s game.
Any he also advocates that individuals should stick with simple indexing which leads me to a question how many indices should the average investor own?
BOGLE: Well, very, very few is a simple answer to that question, you need a broad stock index and you need a broad bond index because I’m convinced that everybody should have a little anchor to windward when these bad times come for no other reason to protect themselves at getting emotional and behaving badly and selling out their portfolios at market bottoms. So leaving the allocation between stocks and bonds, you can buy a bond index fund and you can buy a total stock market Index fund, or you can buy the Standard & Poor’s 500 index fund, and that’s basically 85 percent of the market.
You would think that the that the total stock market would be a better bet because it’s more diversified that the S&P 500 but we’re in a time right now, and I don’t know if this is durable or not, nobody does, where the large companies are doing better than the small companies.
So the great Mr. Buffet does his, he’s leaving his wife’s estate 90 percent in the Vanguard S&P 500 index fund, he has a bet with some hedge fund managers.
RITHOLTZ: He is winning, he is winning the bet.
BOGLE: He’s not winning it, he’s killing them.
RITHOLTZ: He’s absolutely way, way ahead, they actually had to create derivatives for this bet, this is a real bet with millions of dollars of risk on it.
BOGLE: Yes, exactly.
RITHOLTZ: And he looks, it’s a runaway, nobody is else is even in second.
BOGLE: Well, he’s got a year to go.
RITHOLTZ: This is — that’s right,, it will be a decade after the financial crisis, the hedge fund, for those of you who may not be familiar with the infamous bet, a bunch of hedge fund managers were arrogant enough to bet Warren Buffett that they could outperform the S&P 500, he took that bet and it’s not even close, it’s really an amazing story. I didn’t realize we’re only a year away from the final outcome of that bet and it’s theoretically possible they can win but really mathematically, it’s highly improbable.
BOGLE: I think it’s very improbable.
RITHOLTZ: Highly improbable.
BOGLE: Anything can happen, however, I concede that.
RITHOLTZ: Jack Bogle, thank you so much for being so generous with your time, this has been absolutely fascinating. For those of you who are interested in hearing the conversation continue, be sure and check out our podcast extras where we keep the tape rolling and continue chatting. You can check out my daily column on BloombergView.com or follow me on Twitter @Ritholtz.
I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio.
Welcome back to the podcast. Jack, thank you so much for doing this. This has really been tremendously fascinating. It was worth the drive to Pennsylvania to come see you. I’m absolutely fascinated by everything you’ve accomplished.
So we’ve talked a little bit of the advantages of indexing for equities and you mentioned bond funds, there have been some pretty reasonable academic arguments that you can do okay with active management with bond funds because there is such a universe of choices, it’s not just treasuries, but it’s treasuries and it’s corporate, and it’s municipalities. How do you feel about bond funds, do you just own a broad index of bond funds or do you look at active management in bonds and say, well maybe there’s some value-added there?
BOGLE: Well as a group, bond managers cannot win because they are the market.
RITHOLTZ: Right.
BOGLE: And so they will as a group capture the market return, there is just no question about this. And charging as they do, probably and the mutual fund business probably 60 basis, 70 basis points, they just don’t have a fighting chance over the bond fund index.
Now that index has some issues as they say, and I started the first bond index fund, by the way…
RITHOLTZ: What year was that?
BOGLE: 30 years ago.
RITHOLTZ: Okay.
BOGLE: Yeah 30 years ago and it’s done just fine, met the test of competition, but I’m not — I think we can do better in bond indexing than the bond index the way it’s constructed because it’s about 70 percent treasuries and mortgage-backed — good mortgage-backed…
RITHOLTZ: Right.
BOGLE: Government-backed instruments and I think most investors should not have 70 percent in the supersafe category. I think something like 30 percent is pretty good.
RITHOLTZ: So it should be a better assortment of risk that potentially is generating more returns and as long as you’re holding it for decades, the short-term volatility is irrelevant.
BOGLE: Yes, well, you know, the one that I happen to use myself is our intermediate intermediate-term bond index fund, it has — it’s just as volatile or is nonvolatile because that is the same duration or average maturity, and that — but it’s about 35 percent governments, and it’s the same in every other respect. So it has a higher yield, the yield in a bond has a 91 percent, today’s yield, a 91 percent correlation with the return you are going to get in the next 10 years.
So you might as well take advantage of it and I’d say particularly, I mean yes it’s a little riskier, but today people are dying for income, dying for income, and to reach a little bit, I don’t believe in big reaching for yield at all.
RITHOLTZ: Well, that certainly was the cause of problems in the last financial crisis…
BOGLE: Right.
RITHOLTZ: Everybody who reached for yields and said I understand this is subprime but the rating agencies tell me it’s AAA, so I’m going to hold my nose and buy this, didn’t work out that well.
BOGLE: It did not work out well.
RITHOLTZ: To say the least.
So I didn’t realize you had created the first bond index fund, so we have bond indexes, which you would like to see have a little more risk in a little less of the supersafe size, we have already discussed the equity side, let let’s talk a little bit about some of the hot buzzwords that are going around today and I’m curious as I already know what your answer’s going to be but I feel obligated to ask.
BOGLE: Before we get to that, can I just say one thing?
RITHOLTZ: Sure.
BOGLE: We also started in about 19 — well in 1987, to broaden our index base from the S&P 500, we started the bond index fund, we then started — I realize that there is a certain attractiveness to owning the whole markets so we started something called the extended market index fund.
RITHOLTZ: How many holdings are in that?
BOGLE: Well probably, it varies amazingly, but probably right now 2,500…
(Crosstalk)
RITHOLTZ: All right, because Wilshire 5000 is something like 3,400 stocks.
BOGLE: Yes, it’s even less than that, it got up to 7,000 believe it or not.
RITHOLTZ: Late ’90s.
BOGLE: Yes.
RITHOLTZ: When we were cranking out a lot of new companies before we realize that pets dotcom wasn’t a sustainable business model.
BOGLE: Exactly.
So I also had an idea that growth might do better than value for the first for young people investing on a dollar averaging basis, wouldn’t be that much riskier. And when they retired, they might want an income fund so I checked — I divided the S&P into two, as soon as the S&P did that, I started the growth index fund half of the S&P and a value index fund, the other half, didn’t work out very well, it worked out fine from a performance standpoint but what we found is the money poured into growth when growth was doing well.
RITHOLTZ: At the wrong time.
BOGLE: And out of growth and into value. So you know sometime, I think we got to be very aware of creating things that we know investors are going to use badly. No, we don’t tell them what to use and how to use it, but it happens and it’s a responsibility of us, the sponsor, to do that.
RITHOLTZ: So that raises a really significant question which is how important is investor behavior to long-term returns and what can the average investor do to make sure that they don’t shoot themselves in the foot?
BOGLE: Well the first thing to do is don’t chase performance, don’t — some salesmen are you reading the paper for that matter and blame the salesman to this, it says here’s a new manager on a new fund and it’s really doing great or an old manager and the fund was doing great, and this fund is a great 20 year record. Turn away from that because it’s next 20 years aren’t going to be anywhere near as good as its past 20. There are plenty of examples of that with all due respect to my friends up in Boston, Fidelity’s Magellan fund was a star fund for roughly 20 years.
RITHOLTZ: Fantastic, Peter Lynch and then his one of his successors did really well, Peter Lynch was a superstar performer and then what happens?
BOGLE: Well, with a tiny little fund too, don’t forget that, and a fund that wasn’t even offered to the public for five or six years.
RITHOLTZ: Oh really?
BOGLE: Oh yes.
RITHOLTZ: Very interesting.
BOGLE: We all have our little secrets and that so I think overrated, but Peter Lynch was certainly a good manager, but you know, his principle, if you see a product you like, buy the stock, you know makes no rational sense I’m sorry to say.
And Peter Lynch also at Magellan fund’s heyday said in words of one syllable, in variance (ph) most investors would be better off in an index fund.
RITHOLTZ: I read that, was it at variance (ph), I know I read that from him somewhere.
BOGLE: And that is not a concession, that’s the truth.
RITHOLTZ: Well, you have him saying that, you have Warren Buffett saying that, we have a number of people…
BOGLE: David Swensen.
RITHOLTZ: Swensen at the Yale Endowment, he’s another one, it’s amazing that people push up against this because it’s long-term and boring and there’s nothing to talk about and I guess shouldn’t that lead to the next question, should investing be long-term and boring?
BOGLE: if you want to have a comfortable retirement, believe me you will be less bored in your retirement if you got plenty of money. You will be so on bored if you don’t do it, but you have to go back to work.
RITHOLTZ: So let me ask you about some of the hot buzzwords that are out there in investing these days, and again this is a cheat because I’m pretty sure I know what your answers are, but I feel obligated to ask this.
So your index funds are basically put together by market cap weighting but now there’s something called smart beta which is different ways of assembling an index that don’t rely on cap weighting, what do you think of the idea of smart beta?
BOGLE: Smart beta stupid.
RITHOLTZ: Okay, tell us why?
BOGLE: Well, I mean, I didn’t say, that’s what Nobel laureate Bill Sharpe says, I just quoted him. And that the reason is that the just think about this for a minute, it’s another form of active management to begin with, but if smart beta is good and that means it beats the index, then dumb beta does even worse to the index, right?
RITHOLTZ: Right.
BOGLE: So smart and dumb are different, but why are people going to be dumb if it is so easy to be smart, it’s just another claim that I can do this better.
Now happily and after Wisdom Tree and Rob Arnott’s fund came out a decade ago, his fund is now more than 10 years old, what happened? And the answer is essentially nothing. His fund beat the S&P 500 by I think 30 basis points but it was 20 percent more volatile and therefore at Sharpe ratio, the relation relationship between risk and reward, we’re talking over the numbers but at Sharpe ratio of — I mean this is a guess here, it won’t be too far off, the Sharpe ratio of the 500 like 41 in the Sharpe ratio of Arnott’s fund was 36.
RITHOLTZ: Okay.
BOGLE: So he lost, he had 10 years to prove it, then maybe he will prove it in the next 10 years, who can say? But why would that be? I mean where is all the brainpower? He’s very smart guy by the way, one of the smartest guys in this business.
RITHOLTZ: He was a guest on the show, one of our earliest guess, he’s a delightful Gentleman, I always enjoy his company, and it was really in an insightful thought to say let’s think of different ways to put together — to put together indexes but your position is this is an after fees after everything else once you now you risk-adjust it, you look at all this volatility, your conclusion is this just isn’t worth it?
BOGLE: Well, now even if you look at absolute returns, it’s like 30 basis points better over 10 years, that’s not trivial, but when he has essentially the same portfolio as the index fund with different weightings, you can’t expect anything to be too different, so I think it’s oversold, Jeremy Siegel of Wisdom Tree described this is the new Copernican view of the world, everybody had it wrong and Copernicus said, “By god, that sun is in the middle and the new sun is smart beta” It can’t be, because we are all as a group average and if there are any smart guys over, there are dumb guys over there, smart and dumb both in…
RITHOLTZ: And so net net, when you’re buying smart data, you really buying the distribution of really smart guys, really average guys, really dumb guys, and you don’t know who’s who across all the smart beta funds.
BOGLE: And then think about this one step further, the index essentially guarantee that the dollar value index essentially guarantees you the return that all investors share.
So that’s writ in stone, etched in stone, and smart beta may do a little better, may do a little worse. What is the point of taking the risk when the guarantee of getting the market return is right at your hand? Why would you speculate? Why would you speculate on maybe this guy can do it better and believe me, some of these smart beta funds was for a short period of times, will do it, and some of them won’t. I mean that’s the nature of the beast.
RITHOLTZ: I’ve described it is why do you want a romance alpha and forsake beta when beta is a sure thing.
So that’s smart beta, let me ask you about something else that I suspect I know your answers, this year, commodities have — gold especially has had a huge bounce back, we saw a tremendous commodity run from the early 2000s until 2011, what are your thoughts on things like commodity funds, gold and energy for investors.
BOGLE: No, no, and no.
RITHOLTZ: No, let’s repeat this in case those you missed. Gold, no. Commodity funds, no. Oil funds, no. Tell us why.
BOGLE: Okay, well oil as a — I think of oil as a commodity now and that is think about what a stock is.
RITHOLTZ: Okay.
BOGLE: A stock has an internal rate of return, and it’s composed of the earnings growth and the dividend yield when you buy it. It’s there, if the stock goes up and down, that return is there, it has an underlying internal rate of return.
RITHOLTZ: You have a discounted cash flow from the future, you’re buying an existing business that’s going to generate revenue and profits and you get to participate in that.
BOGLE: Now take a bond, it has an internal return equal to the interest coupon that you are going to get over the next 10 years or 25 years, whatever the case may be, commodities have no internal rate of return.
RITHOLTZ: And there is a cost of storage and security for things like gold or oil.
BOGLE: So when you buy a unit of gold, why do you buy it? Because you think you can sell it to somebody for a higher price, that is the definition of speculation.
RITHOLTZ: That’s the classic greater fool theory, you may have paid a lot but someone will pay more.
BOGLE: Well, I mean you may be right by the way, there is no reason you can’t be right but that just means the other guys is wrong.
RITHOLTZ: And even though as you as the investor, you don’t know which of those two parties you are going to be five years from now.
BOGLE: Yes, and another thing when you mentioned gold is that brings to mind is everybody used to talk about gold, Forbes Magazine highlighted it in all their reviews for years and years when they picked the best fund, gold funds, gold funds, and then we had the boom in gold and we had the collapse and nobody started talking about — nobody talked about gold.
Now we have another boom and everybody’s talking about gold and gold collapses last year, nobody’s talking about gold, now gold is up this year everybody — this is metaphorically speaking, everybody’s talking about gold, don’t pay any attention to gold, I mean it would not be stupid, I wouldn’t do it, but it would not be stupid to have a very small position in gold as a hedge against worldwide hyperinflation, maybe 5 percent, I wouldn’t do any more than that, but I don’t think you should do that, but it’s at least defensible because you have a specific goal in mind and…
RITHOLTZ: It’s insurance, you are paying a 5 percent insurance on the remote possibility of global hyperinflation, but if you are wrong, it’s a giant 5 percent drag on your portfolio for the next few decades.
BOGLE: Yes, and that’s huge.
RITHOLTZ: That is — well you guys are talking about basis points, this is 500 basis points, that’s a tremendous, tremendous drag. Let’s talk a little bit, and by the way, I’m pretty much what I expected you to sat about commodities. Let’s — let me find two things to talk to you about that I’m going to have to push back a little bit. One is ETFs, exchange traded funds, I know you’re not a big fan of them but lots of investors find it’s a very inexpensive simple way to get exposure to the S&P 500 or whatever asset class they want, why are you not a big fan of ETFs?
BOGLE: Well I’ll start with a little anecdote.
RITHOLTZ: Okay.
BOGLE: A wonderful guy named Nathan Most came to visit me in 1992, right, my office upstairs here at Vanguard, and he said I have a great idea for you. We — I want to start the first exchange traded mutual fund and have Vanguard as my partner.
There I was, I could have not only created the first index mutual fund, but the first ETF and I said “Nate, no way” because the description that you got from Nathan or at least our first ads later on was now you can trade the S&P 500 all day long in real time and I would say…
RITHOLTZ: That’s a bad idea.
BOGLE: What kind of a nut would want to do that? I mean there must be better things to do than that in this life, but in any event it’s a trading idea, when my idea of indexing broad market indexing by the S&P 500 and hold it forever is said to be Warren Buffet’s favored holding period.
RITHOLTZ: Is forever.
So the idea of an S&P 500 funds that if you are going to do that exposure, you’re better doing it with a low-cost mutual fund, than an index funds, than an ETF, so there is no temptation to trade intraday or to play around, that’s not what you think people should be doing with their time?
BOGLE: Or not but let’s examine the ETF business for just a minute, and that is if you look at ETFs, all the big ones, I mean I can’t look at all of them but the big ones particularly and the normal ones that are about 70 percent owned by financial institutions, they are trading them in the marketplace every day.
RITHOLTZ: Right.
BOGLE: The SPDR, the S&P 500 ETF…
RITHOLTZ: Or the NASDAQ 100 well…
(Crosstalk)
BOGLE: Well, the SPDR is the most widely traded stock in the world every day and if you look further this year, which is a little more volatile than most years so far, the dollar volume of trading in ETFs is the same size as the dollar volume of trading in common stocks.
RITHOLTZ: Wow, unbelievable because common stocks are worth about $23 trillion, and the SPDRs are worth about two, so SPDRs are turning over 3000 percent a year and stocks are turning over at 200 percent a year or something like that. So they are trading instruments owned by large institutions.
And look at the SPDR ad that says institutions, here’s what you need to trade, I mean it’s practically verbatim from the — it just — it may be irrelevant but I don’t think in the long run that has anything to do with the mutual fund business for individual…
RITHOLTZ: And it certainly shouldn’t have anything to do with individuals because why would you as an individual want to trade against these giant institutions who do nothing but use this as a — either a trading tool or hedging tool or whatever it is, you’re saying this is not a playground for individuals to step into.
BOGLE: And that looks like it’s roughly 70 percent of the business and I don’t — even to criticize it, it’s kind of irrelevant, when you get to the other 30 percent of the business that I may be a little off in my percentages here, but there are individuals and you know something like two thirds of them are using ETFs to trade and one third of them, that would be 10 percent of the total all the ETF market are using them, buying and holding them, and maybe using them know we have it’s a funny technical thing in this business, but if you want to put in $1000 a month into a Vanguard Fund and you want take out $5000 at the end of the year to buy Christmas presents, whatever you might want, it’s very difficult to do that here because we don’t like buying and selling at the same time. You can do it with our ETFs very easily. So there is a certain marketplace there of people who aren’t traders but like the flexibility ETFs have and I’ve no problem with that.
The other part of the problem however, the ETF problem, is there is a huge amount in number not so much in asset of funds that are doing things that no intelligent investor would ever do, triple leveraged and you can bet every day whether the market’s going up or down, isn’t that grand…
RITHOLTZ: Not only triple leveraged up but inverse triple leveraged as well.
BOGLE: Sure, as long as you know whether the market’s going up or down during the day, you are going to make a fortune.
RITHOLTZ: Who knows if the markets going to go up any or down any given day?
BOGLE: Well I guess the smart people that have these funds but they all have both of them.
RITHOLTZ: That is right.
BOGLE: They don’t compete with each other. And there are a whole lot of other wacky things, I mean I don’t think US investors — I’m sure you’re going to come to this, should be buying individual foreign — non-US…
RITHOLTZ: So let’s ask that question, a lot of the academic data says that if you’re diversified internationally, parts of the world are sometimes doing better than the US and sometimes US is doing part of the world, if we want to really be diversified, you need US and not just have an overwhelming home country bias developed world ex-US, and then emerging markets, what’s wrong with having a smattering of those in your portfolio so that you get to take advantage of the growth of the Pacific Rim and China and South America and et cetera.
BOGLE: Well the question is, is it an advantage? I mean tell someone who put all their money in Brazil two years ago, tell somebody who put all their money in China a year ago, is it an advantage or is it just, you know, kind of a little bubbling going on in those countries…
RITHOLTZ: Well, but you are not picking individual countries, you are going to have a broad index of international companies and therefore it should theoretically — the gain should offset the losses and then some, and so you have exposure elsewhere. You are not a big fan of that.
BOGLE: Well I’m not and the reason goes back to when I started to think about it seriously writing my book “Bogle on Mutual Funds” back in 1993, ’94.
RITHOLTZ: “Bogle on Mutual Funds” let’s see what I have here, I have “Common Sense On Mutual Funds”.
BOGLE: That’s probably says something very similar to this but this is a little more recent, so I said…
RITHOLTZ: Tenth edition, forward by David Swensen. So when you say recent, this game originally came out almost 15 years ago, right?
BOGLE: The original was 1999.
RITHOLTZ: Okay, 17 years ago.
BOGLE: Interestingly enough, I will get back to the other subject in a second but interestingly enough, the first book came out at a market high and the second — 1999, and the second book came out in a market low and I would hardly change one word in the whole second edition.
RITHOLTZ: Really?
BOGLE: I reprinted it verbatim and then marked — put red and tuck it red for any changes that took place in the book…
(Crosstalk)
RITHOLTZ: Now on the tenth edition, that’s– after the financial crisis, you could see some of the changes that were made but they’re really very modest, you really didn’t change any of the themes in this, you just kind of fleshed it out post crisis.
BOGLE: It worked, indexing worked, and the good market indexing worked in the not so good market, and cost, low-cost worked in the good market and also in the not so good market, it has to.
So getting back to I said in my first book and, look US companies get half of the revenues this is true now at least, a little bit less than half of their revenues and half of their earnings from outside the US, you have an international portfolio, why do you want a larger one?
And then I say take a look at what comprises that international portfolio, your largest investment is Japan, your second largest investment is the UK, your third-largest investment is France. Now if returns are developed out of national economic strength, does anybody think that the UK and Japan and France are going to better than the US in the next 10, 15, 20 years, I can’t imagine it.
And now I may be wrong, I’m not saying this is written in stone, but that’s 45 percent of the money, so if people knew they were putting 45 percent of their international money, so-called international non-US is a better formulation, in Great Britain, France and the Japan, I mean every one of those economies has real problems, the French don’t work very hard, the Japanese have a structured and deeply aging economy overburdened by future retirement claims.
RITHOLTZ: Right, terrible demographics and they are a great exporter but they have issues.
BOGLE: And Britain doesn’t know what’s going to happen if they do the exit from the European Community and nor do they know what is going to happen if they stay in.
RITHOLTZ: So what would happen if a sharp but upstart company, let’s call them Vanguard, says here’s a broad international index that’s fairly evenly weighted, it’s not just these three countries, might that change your perspective or do you still think, “hey you get plenty of the S&P 500, half the revenue comes from overseas, that’s all the overseas exposure anyone really needs
BOGLE: I don’t like the idea because you have as much and I don’t know Honduras…
RITHOLTZ: Right.
BOGLE: As you do in Great Britain, it wouldn’t make any sense.
RITHOLTZ: Right.
BOGLE: So, but to make matters worse when I made this statement in 1995, we now have 22 years of history…
RITHOLTZ: Right.
BOGLE: How was the prediction? And the answer is that don’t quote me the exact numbers but that the US portfolio is up about say 750 percent and the non-US portfolios are up about 275.
RITHOLTZ: So the US is still winning versus the international.
BOGLE: So I committed the elements in, Barry, I was right.
RITHOLTZ: (LAUGHTER)
BOGLE: Now I want to be very clear on this, does that mean I will be equally right in the future? I can’t imagine it.
(Crosstalk)
RITHOLTZ: You think eventually a reversion comes in yeah and eventually those two positions will reverse, the US…
(Crosstalk)
BOGLE: Well I don’t think they will reverse, but I don’t think that spread is a durable spread and the reason I don’t think that will reverse is we have this fabulous economy here. I mean, yes, it has problems, but probably, less problems than any country in the world.
RITHOLTZ: No doubt about that, my favorite quote is this is the cleanest shirt in a dirty hamper.
BOGLE: Sure, exactly right. And well, I mean I’d say it was even cleaner than that, we’re number one in innovation and technology, we’re not number one in entrepreneurship, we’re still a great manufacturing company although not as great as we were and we still have all these new companies being started — existing company being run more and more efficiency, and more than anything else or at least as much as all that, we have great institutional structure in this country.
We have legal protections, we have courts, we have laws, no one is going to take your stock away from you, confiscated overnight, and the shareholder rights are as good as any country in the world maybe with the exception of — I don’t think they do any better but they don’t do any worse, probably Switzerland and Great Britain would be that the two big competitors.
RITHOLTZ: You see you see what happens in China, your stocks may not be your stocks, it’s very hard to be forget as a local, as an international investor, it’s very hard to be an investor in China if you don’t know am I to going to be able to ever cash it out or maybe there is going to be a vacation period where no sales for the next month as we saw last year.
BOGLE: Yes, and let me add to this, just about everybody says I’m wrong, by the way, but everybody said I was wrong about indexes…
(Crosstalk)
RITHOLTZ: I was going to say that’s only going to make you — that’s only going to make you double down and think you’re right because there is a track record of people predicting you are going to be wrong and they’ve all proven themselves false. So…
BOGLE: But let me just say one more thing in international. Just think what you would’ve done if you had an internationally weighted or a non-US weight with — in 1989 when you had 50 percent, that is to say 5-0 percent of your money in Japan.
RITHOLTZ: Right, when the Nikkei was 46,000 or so.
BOGLE: Yes, something like that. No one was talking this way then and that could happen again and I don’t think you should be subject to these funny speculative booms that can take place in other countries. I just can’t imagine that there will be a significant advantage in international companies over US counties, I’m not talking about stocks now, I’m talking about companies and economies over the US.
Now, look I could be wrong on this, if you think I’m wrong, go buy all international, all the non-US stocks you want, buy a non-US stock index, buy individual countries, I wouldn’t do any of that.
RITHOLTZ: And we didn’t even mention the currency side of things, how significant is currency fluctuations to this sort of international exposure if you’re domiciled here in the US?
BOGLE: What kind of…
RITHOLTZ: Currency, currency.
BOGLE: Oh currency, sure. Well that is an issue because the dollar has been very strong, and it won’t be strong forever because international trade has a way of balancing out when the dollar is strong, the trade balances change and all that so I don’t think you should count on a good strong dollar forever.
RITHOLTZ: So it won’t impact it.
Let’s talk, I want to talk a little more about Vanguard but before we get to that, two last questions about indexing, the first is there any sort of active management you would favor Vanguard about 30 percent of the assets you are an active managed funds, what do you think about having a small slog of someone’s portfolio in something that might not be a passive index?
BOGLE: Well, let me give you this very important background of our actively managed funds, and this is what I’ve been saying since we started Vanguard in 1974. I want our active management — actively managed funds to have returns that are relatively predictable, relative predictability, y relative to their group like large cap value funds, long-term is municipal bond funds, whatever it might be. And the idea would be look at those funds and not — don’t get too far out of line. So you’ll have an average — if you have six managers, this is where the multi-manager thing comes from, if you have six managers, the idea that they will do about the same as another as your competitive group with 60 managers is almost guaranteed to do the same.
So what’s so good about that? What’s so good about that is we think we have a 1-1/2 percent to 2 percent cost advantage through lower expenses, lower turnover, no sales loads, and we should win by a point in half a year not on brilliance but on cost. That is guaranteed….
RITHOLTZ: So let me…
BOGLE: Let me just give you the punch line here, if you win, what’s a good about one and a half percent over 10 years, you have a 20 percent higher return.
RITHOLTZ: That’s tremendous.
So I previously interviewed your CEO and Chairman Bill McNabb and one of the comments he had made is that he still felt there was room to squeeze costs lower. You guys are $3.5 trillion, is there a floor on how low cost can go or you eventually going to run out of efficiencies?
BOGLE: Well we have yet to squeeze cost lower because our cost go up and up and up.
RITHOLTZ: But as a percentage, you can squeeze them on a lower…
BOGLE: As a percentage.
RITHOLTZ: On a per, well, dollar invested basis.
BOGLE: I don’t want to disagree with our CEO, but it’s not we’re squeezing but we’re the captive of the market, if the market goes way down, our expense ratio is going to go up.
There’s no way we could squeeze enough out of our expenses if we had 15 percent less asset, so we should be very careful about expenses and we are, I think we’re managed in a very strong way, but where the expense ratio is a combination of something we can control more or less how much we spend, it’s something we can’t control at all the level of the stock market.
So the expense ratio is a mystery whether it go up or down. Now it if it goes way down, it’s going to mean we have very good markets.
RITHOLTZ: That sounds great. Can indexing ever get too big or can indexing ever take over the market as some people have alluded or is there a place for a combination of indexing and active managers in the actual marketplace?
BOGLE: Well, it’s not in the nature of things, indexing could be 100 percent of the market. If it were, we would have chaos, there would be no valuations, there would be no liquidity, there would be no anything. So what are the chances that indexing, you got to do 100 percent zero, right now it’s I think around 28 percent of the total market, 35 percent of the mutual fund industry or the equity mutual fund industry, and the so it means that that hunk of business is in broadly stated just removed from the turnover level so it’s a turnover worth 100 percent in the end market, we are 50 percent indexed, the turnover would go to 50 percent.
I came into this business when turnover was 25 percent and everything was fine, and it’s going to take a long time to get to 50 percent, a long, long time and maybe never gets there. So when you put reality in the face of the theory that if everybody indexes and then it’s going to be — just not going to happen.
But the other thing is people follow this statement by saying if the market gets more and more indexed, then it would be less efficient and we’ll be able to beat it more easily. No.
RITHOLTZ: (LAUGHTER)
BOGLE: Unequivocally no, some will beat it, some will lose to it, if the market is less efficient and the winners and the losers will average the market return, there is no way around that.
RITHOLTZ: So that leads me to a quote of yours and I have to ask you about it because I find it’s fascinating you once wrote “The stock market is a giant distraction to the business of investing.” Explain.
BOGLE: Well, investing is about the long-term and investing is about earning what I call the investment return which is the dividend yield when you go into the stock market and the earnings growth that follows. That’s investment return.
The market return also has a speculative return and that is the price earnings multiple of evaluations high or low when you come in? And if they’re hire, they are going to detract from that return, and if valuations are low, they are going to add to that return because the low — the valuations price-earnings multiple reverts to the mean perfectly, it’s about what it today — and also it’ll be higher than this today because the market’s a little bit, is hardly inexpensive but the reality is it’s just about the same level as it was in 1900.
So we had ups and downs, booms, bust in the long run, speculative return is zero. So concentrate on the investment return, forget the invest — the speculative return which is very difficult to predict and just get what business can give you. Now if you look every day, you’re apt to do something, and one of my basic rules is don’t do something, just stand there, and if you’ve been doing that this year, I think you’re a lot better off, this is a tough year so far, not that bad, I mean I think the S&P is off about 3 1/2 percent, it’s really nothing.
And while you think it was the end of the world, and so it’s don’t let the stock market moves distract you, they are a tale told by an idiot, these moves, daily moves, hourly, minute by minute moves, a tale told by an idiot full of sound and fury signifying nothing.
RITHOLTZ: I have a bunch of questions that I ask all of my guest but they are all specific to each individual because they’re so detailed. So who are your early mentors? I know in one of your books you mentioned somebody, you thanked somebody who you had mentioned in the earlier part of the conversation, who do you think of as mentors?
BOGLE: Well, outside of my teachers, my first real grown-up mentor was a guy Jim Harrington, he was a graduate student, an engineer at Princeton University and he was running the athletic ticket association ticket office and when he stopped doing that, he pulled me out of the crowd and asked me to run it for him.
So I learned how to do a job, and I learned how to do it with integrity, and I learned how to do it on time, and I learned how to do with keeping my emotions out of it.
RITHOLTZ: This is just selling tickets to Princeton students for sports events…
BOGLE: Football, basketball, baseball, whatever it might be, particularly football.
RITHOLTZ: And that was a seminal experience to you and helped form your own character.
BOGLE: He had just a great sense of business values, and like all engineers he was you know, that kind of go step-by-step…
RITHOLTZ: Right.
BOGLE: Sometimes isn’t all that exciting but it’s always right.
RITHOLTZ: Structured, organized, and…
BOGLE: You are dealing with a lot of money and…
RITHOLTZ: Sure, Princeton Stadium is how many people?
BOGLE: That was the old Palmer Stadium and that held 50,000 people.
RITHOLTZ: Right, and now it’s almost double that size, it’s huge, isn’t it?
BOGLE: No, we went way down. We are about 28,000 now.
RITHOLTZ: You went the other direction, okay?
BOGLE: And we can’t fill it now, we used to — every game I worked was a sell out.
RITHOLTZ: Right, that was back in the day, so that was really a quite an education.
You dedicated “Common Sense Of Mutual Funds” to Walter Morgan, who is he in your Pantheon?
BOGLE: Well, he was the greatest of my mentors, he hired me, he read my thesis out of Princeton, he wrote I think a little bit over the top that Mr. Bogle knew more than he did about — than we did about the mutual fund industry.
RITHOLTZ: Really?
BOGLE: And so he liked it and he was a Princetonian himself, class of 1920, and I was the class of 1951, and I watched him work, he was very much a Renaissance man, interested in investing, interested in marketing, probably less interested in detail of the business shareholder record-keeping and stuff which was so much simpler in those days, but also a Renaissance man in terms of his interest. He was an outdoorsman, a hunter, a fisherman, and things that I don’t do at all. But he had a high sense of standards and he was at the beginning and turned the company over to me when I was 35 years old. So he must have had an awful lot of confidence in me.
And I saved Wellington Fund finally for him after this catastrophe I described earlier, we told Wellington Management Company how we wanted to run and they have been running it that way ever since, much more focused on income and income stocks and less focused on growth stocks and it’s worked out, we had a whole renaissance of the Wellington Fund. And he saw a lot of that, and he was– he died the year that book came out and a little bit before but I have shown him the title page with his name on it, he was very pleased and very pleased with the revival of renaissance of his wonderful Wellington Fund, I felt like I had a moral obligation to say that.
RITHOLTZ: So what about other investors, who hasn’t influenced your thought process, your philosophy, perhaps not your approach to investing but what other investors have colored your worldview?
BOGLE: Well you certainly start with Benjamin Graham, and he’s the basically Ground Zero, and “The Intelligent Investor” his book, I have like the fourth edition which is much more into the — it was 1974 and has much more about mutual funds and things of that nature, and he was very clear on that, and so he would certainly be one.
Mr. Morgan, Mr. Morgan had a couple of associates, Joe Welch (ph), the president of the company and Andy Young, his lawyers, a very quick witted smart guy and they all saw something in me, don’t know what it was that gave them confidence that I had the judgment to do the job.
And another, interestingly enough, another one of the great mentors was a man when I came on the investment, got me to board of governors, he was the chairman, his name was the George Sullivan, and he was Executive Vice President of Fidelity.
RITHOLTZ: Oh really.
BOGLE: And we had a great relationship.
RITHOLTZ: That’s fascinating.
BOGLE: And so he would’ve been, if people have confidence in you, they bring out your best and he really did and Mr. Morgan did, and Mr. Welch did, and Andy Young did, and so that those would be the big names I think…
RITHOLTZ: Both as mentors and investors.
Let’s talk about books, you’ve written your fair share of books, whose — what other authors books be it on investing or what have you have you enjoyed? What books would you recommend to people?
BOGLE: Well, I’ve already mentioned the…
RITHOLTZ: “Intelligent Investor” by Graham.
BOGLE: Yes. “Intelligent Investor” by Graham, I think Burton Malkiel who is a friend of ours, and a friend of mine and a former director here for many years, and really the best director we’ve ever had, outside director, his “Random Walk Down Wall Street” which is updated every couple of years is another.
David Swensen’s book on for the individual investor is really superb, Peter Bernstein’s “Against the Gods” is top of the line.
RITHOLTZ: I just read that over the holidays, fantastic book.
BOGLE: He was a very gifted man, we are very close, Peter and I we had our little disagreements here and there but overall, we’re on the same team and then Bill Bernstein, “Four Pillars Of Investment Wisdom” is a wonderful book, and there aren’t — and it’s hard me to go a lot beyond that to be honest with you.
RITHOLTZ: Well, that’s a great starting list right there, you could certainly do worse than any of those half-dozen books.
We’ve talked a lot about how you’ve changed the industry since you began way back in the ’60s and ’70s, how else has the industry changed that you think is either for the better or for the worse? What stands out as to how finance has evolved over those years?
BOGLE: I think when I came into this industry in 1951, it was a much better industry than it was thereafter. A big part of that change was in the go-go era when we had this idea, we went from investment committees, prudent investment committees, buying blue-chip stocks to portfolio managers, comets and not stars, comets that burnout and their ashes drift gently down to earth, and that’s happened to so many — so many comet managers, I mean you could hardly lose count.
You wonder, the real superstars just don’t stay there, and you know, just to wish Bill Miller well, he beat he’s at Legg Mason, he beat the market I think 16 years in a row…
RITHOLTZ: Right.
BOGLE: And every time I saw him, I’d say good luck, good luck in the future, I liked him. My wishes of good luck didn’t do any good at all.
RITHOLTZ: He very famously imploded and went from the literally the top-performing funds to the bottom 1 percent following the financial crisis, what had worked for him previously just eventually stopped working and he got caught in a lot of paper that turned out to be not worth what he thought it was.
BOGLE: Well, in an earlier era, you remember Gerald Tsai who ran Fidelity Capital Fund? And he had the best record in the business, he goes out and start his own fund, a Manhattan fund, gets a huge underwriting, it was $400 million, no one has ever seen anything like that in this business, that was the old days and it had after 10 years of operation the worst record in the mutual fund industry and I tell people when you think about the nature of securities markets, it’s just as difficult to be last as it is to be first.
RITHOLTZ: What was his name again?
BOGLE: Think about that.
RITHOLTZ: What was his name again? That’s amazing. What was his name again?
BOGLE: Gerald Tsai, T-S-A-I.
RITHOLTZ: T-S-A-I, great. So some of my last few questions, you’ve mentioned a lot of things have changed since 1951, what you see is changing in the future?
BOGLE: I guess I’d say not to beat the phrase to death, reversion to the mean, I see the industry going back to its roots, much more fiduciary focus…
RITHOLTZ: I hope so.
BOGLE: I’m very much in favor of the fiduciary rule although someone else’s got to have to work out the details that seems to make it difficult to operate and but…
RITHOLTZ: It shouldn’t make it difficult to operate because all you have to do is ask yourself as an advisor one question, “Hey is this in the clients’ best interest?” and if the answer is no, you can’t do it.
It’s much simpler than the complicated suitability rules which have all sorts of ifs and thens and clauses, best interest of the client, yes, you can do it, no, you can’t, what could be — what could be easier?
BOGLE: Well, you unfortunately need kind of documentation to how you’re doing things and all and it is a laborious because we have to have a lot of lawyers work on this and that you and I have the spirit of fiduciary duty and they’ve got to get to the letter of it and it’s more complex than it ought to be, but it’s coming, and with so many funds being flashes in the pan, investors are going to learn by their own experience.
I was told this was a great fund and was a great fund for two days and that was the end of it. And we overestimate our own ability to pick funds and stocks. We overestimate the ability of our managers to do better consistently and people just got the idea of reversion to the mean again and again and again. We were looking at some data the other day, Barry, and that if you’re in the top quartile for a given five-year period, only 15 percent of you are going to be in the top quartile of the next five-year period.
And if you’re in the bottom quartile, 15 percent of you will be in the top quartile in the next period.
RITHOLTZ: And over time, that sort of returns don’t help anybody. I think it was Howard Marks who said if you’re consistently in the top 40 percent over time, that puts you in the top 10 percent but you have to be consistent, you can’t be a shooting star outperforming, underperforming, outperforming, underperforming, you have to be top 40 but he runs a distressed bond fund, not necessarily a stock picking.
BOGLE: Let me add this if I may, what is the objective of the individual investor? It’s to have a lifetime of investing, investing for a lifetime, and for a young investor, believe or not, a 25 year-old investor has a 70 year life expectancy, 70 years they are going to be 95, they’d probably be 100. So what’s the best way to invest for 70 years? If a mutual fund manager lasts for seven years, that’s the average, you are going to have 10 of them.
RITHOLTZ: Wow.
BOGLE: The average fund goes out of business 10 percent every decade, 50 percent every decade, excuse me…
RITHOLTZ: Really, it’s that high, that’s amazing.
BOGLE: Yes.
And then the new guy comes in and sweeps clean.
RITHOLTZ: Right.
BOGLE: Managers get fired, there is no way, none, zero, that if own three or four mutual funds which is typical, there is no way that over 70 years, you have even a fighting chance to beat the market, and if you do the index fund, I guarantee you that you will have the same nonmanager 70 years from now as a non-manager you have today.
RITHOLTZ: So that raises a really interesting question which happens to be coincidentally one of my last two questions. What advice would you give to a millennial or a kid just graduating college today beginning their career? What would you tell them about what they should do with their career and what would you tell them about investing?
BOGLE: Well, people have to find their own way in this life, and I talked to a number of groups at Princeton and one on religion and business and one on ethics and business, two separate groups, and one is a small seminar in one is a large lecture course. And I get that kind of lecture. Should I not go into the financial business? And I say no, go into the financial business and make it better than it is today.
People have to find their own way in this life, I had to find my own way, Barry, you had to find your own way, a lot of bumps along the way, you got to have a little resilience, you got to be able to take defeat and turn it into victory, I think that’s what I’ve done, maybe a little bit and…
RITHOLTZ: To say the least.
BOGLE: And so this deal is going to shrink hugely, there’s no question about that.
RITHOLTZ: It already has, just since ’09, no doubt about it.
BOGLE: The combination of technology and the knowledge and the spread of this disease called indexing is not going to go away, it’s habit-forming, it’s catching, it’s contagious.
RITHOLTZ: It is spreading. And my final question and I’m — I feel awful that our 90 minutes is already up, I’d like to continue going for another 90 minutes, what is it that you know about investing today that you wish you knew when you started in 1951?
BOGLE: Well I’d say quite a bit, I mean I was on the Wellington Fund investment committee and I saw how hard it was to beat the market, I wouldn’t have told you that back in 1951 and I worked for a long time with John Neff who had many, many years of success in beating the market, but he is an exception and even his record in later years deteriorated, but then he’s not running Windsor Fund, he ran it r 30 years I think, but he’s not running it anymore.
So managers come and go, so I’d say things like the power of compounding, the beauty of keeping costs low, and the need to ignore the market and the need to do something are all things that — and the difficulty that this is a very, very hard business, this business of investment management.
And in the long run, we’re all average or below average as my thesis suggested, below the market averages, and so don’t think it’s easy, don’t think you’re smarter than anybody else, just get in the middle, get cost out and don’t peak.
RITHOLTZ: John Boggle, this has been a fascinating conversation.
I again thank you so much for being so generous with your time.
If you enjoyed this conversation, you could look up an inch or down an inch on Apple iTunes and see the other 80 or so of these that we’ve had. Be sure and check out all the rest of our chats, they’re really quite fascinating.
I have to thank Mike Batnick, my head of research for helping to put together all these questions, my producer and engineer, Charlie Vollmer for dragging himself out of bed at an ungodly hour in the morning to drive here to Malvern, Pennsylvania to Vanguard mothership.
Jack, thank you again so much, this has been absolutely fascinating.
BOGLE: Great to be with you, Barry.
Good luck.
