Consuelo Mack WealthTrack - November 16, 2012
CONSUELO MACK: This week on WealthTrack, legendary investment crusader John Bogle discusses The Clash of the Cultures: Investment vs. Speculation, his lifelong battle against the forces of Wall Street greed in his quest to help individual investors get better returns. Investment pioneer and reformer Jack Bogle is next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. We have a special treat for you this week, an extended interview with one of a kind investment legend, John Bogle. Jack, as he is known to many of us, is the founder of Vanguard, the low cost investment giant famous for the index funds which he created there in 1976. His first index mutual fund, now named the Vanguard 500 Index Fund (VFINX) because it is modeled on the S&P 500, now has over $100 billion in assets, as does its equivalent fund for institutional investors. If combined, they would be the world’s largest stock mutual fund.
Vanguard itself is now managing around $2 trillion in assets, making it the largest mutual fund company in the world. And it’s growing rapidly because of its low cost, largely passive investment model. Called a mutual company, Vanguard is the only mutual fund company owned by its fund investors, not private or public stockholders. Bogle set it up that way to, as he puts it, insure it would act as a pure “fiduciary”, putting the interests of its investors first. One measure of that goal is costs. According to Vanguard, the average expense ratio for its stock funds is point two percent of the assets under management, or 20 basis points- one hundred basis points equals one percent; that compares to the industry average of .79 percent, or 79 basis points, nearly three times more. And fees at actively managed funds are usually considerably higher than that.
Investors are taking note. The well-publicized withdrawal from more expensive actively managed funds into index funds has accelerated over the last two decades and exploded in the last couple of years. From $26 billion in 1993, traditional index funds now have over one trillion dollars in assets. Their much younger and incredibly popular offspring, exchange traded funds, which are index funds traded like stocks, have exploded from $464 million at their launch in 1993 to well over a trillion, surpassing their older mutual fund brethren. In total, index funds make up 28% of total stock fund assets and counting.
From the very beginning of his career, Jack Bogle has been a tireless advocate for individual investors and an outspoken critic of much of the money management industry. It’s the focus of his tenth and he says last book, titledThe Clash of the Cultures: Investment vs. Speculation. I began the interview by asking Jack about the changes that have occurred in the industry during his 60 plus year career and what it was like when he started in the business in 1951, at the actively managed and still thriving Wellington Fund.
JACK BOGLE: One is we were small as an industry. Wellington Fund was probably one of the ten largest funds with $140 million dollars. We probably employed about 40 people in the company, and we had one fund- one fund- and so everybody knew, the research people and the administrative people, the marketing person. Everything was focused on that one fund.
That was our other people’s money, and we had a fiduciary duty to those people, and we honored it very well. Wellington Fund was noted for low cost, noted for balanced investing mixed between bonds and stocks, very consistent over the years and very much dedicated to serving the investor- long-term investment philosophy, very low portfolio turnover, and I and anybody else that was working there got the history of the fund, how it got through the ‘30s, how it got through the ‘40s, post war period, all the way up to 1951, and it’s kind of interesting that I got there in 1951, and here it is 2012, and I’ve been there ever since. Now, I’m just senior chairman right now... I’m sorry, honorary chairman, but I’ve been associated with that one fund all that time, and I know it like the back of the hand. There’s a good story there if we could talk about it later.
CONSUELO MACK: So when you’re talking about you knew you had a fiduciary duty to your shareholders, what did that mean to you back then, and...
JACK BOGLE: Well, that’s a great question, because I’m not sure we used the word fiduciary. Might have used the word trust, but we knew what our job was. It was to serve the Wellington shareholders, and that’s... you know, if you actually just understand that concept, that came first, and that’s in the form of a sound investment program, a careful one, a long-term focus and very low cost, and if you don’t have those kinds of things, you’re not observing fiduciary duty, and you’re not earning the shareholders’ trust, and so the fund burgeoned in growth, but what happened to the industry as it went from, back then, $2.5 billion to $12.5 trillion today. It grew up.
CONSUELO MACK: Big business.
JACK BOGLE: Big business, and then it was pretty much organized by professionals who ran money, not marketers.
CONSUELO MACK: And you talk about the distinction in the book, that you talk about this clash of cultures. Is it there’s an investment state of mind and an investment profession, and that you’re saying that profession has now become a business, and it’s become one of speculation. So what’s happened? Take us through the evolution, because again, you started in 1951 when it was small and it was fiduciary, and it was a professional investment business.
JACK BOGLE: Marketing was over here, and management was over here. Salesmanship was over here, and stewardship was over here, and to just moderate the phrase you mentioned a minute ago, in those days it was a profession with aspects of a business. Today, it’s a business with aspects, and I think too few, of a profession. Now, that change comes by growth, the old mom and pop professional industry. It was a great big industry run by not investment professionals, but by corporate managers and in far too great an extent, and it also happens along the way that instead of one fund, you now have a large fund complex, and they have 200, 250, even 300 different funds. How can a fund director have fiduciary duty to 300 different funds? Indeed, a little bit tongue in cheek. How many mutual funds directors can name all the funds they’re directors of, and I will tell you the answer to that question is zero.
So I have a little lower test. How many fund directors can tell you the number of funds that they’re director of? And I guess the answer to that might be a tenth of one percent. So the idea of fiduciary duty has been superseded by this idea of marketing, making things that will sell rather than selling what we make is the way I phrase it, and so if a bunch of investors seem to want some new kind of a leveraged thing or a short-term focused fund, whatever it might be, give them one. What is marketing? Marketing, the classic definition is finding out what the public wants and giving it to them. I could spend 100 years trying to find a better definition of what a mutual fund company should not be.
CONSUELO MACK: So what should a mutual company be? And you founded Vanguard which is now a very large mutual fund company, and it has many different funds. So what should a mutual fund company be? Is it possible to still have a fiduciary standard among the money managers and still have a big marketing arm that really doesn’t have a lot to do with the money managers except to represent the funds that they’re managing? I mean, can’t you do both?
JACK BOGLE: Well, it’s very difficult to do both. The fund, just to be clear, the management company has its own officers and directors, and they’re often, maybe the vast majority of mutual funds, have management companies that are owned by financial conglomerates, and these financial conglomerates are in business to earn the highest possible return on their capital, and what you want as an investor in one of their mutual funds is to earn the highest possible return on your capital. So when you think about it, those two things, because of fees and costs and turnover expenses and all the things that go on, marketing, are opposed to one another. You can’t do both. Or as a book we’ve all read carefully says, “No man can serve two masters.” So the structure of the industry is inherently flawed, and it will have to change.
CONSUELO MACK: How does it have to change? Realistically, how can it change? Let me start there.
JACK BOGLE: Okay, I’ll give you two answers, two ways it can change that I’ve thought of. One is what I call the Adam Smith solution, and that is if each investor looks after his own best investment interest and puts the money with the firms that best serve his own interest, then the industry will change. He’s going to demand a long-term focus. He’s going to demand prudent management. He’s going to demand low expenses. He’s going to demand to get his fair share of whatever returns the fund makes, his or her fair share of whatever returns the fund makes.
CONSUELO MACK: Name names. There are some funds out there that represent the kind of values that you think serve investors.
JACK BOGLE: There are some funds, very few. I like Longleaf down in the south. They run the funds as fiduciaries. I like Dodge & Cox out in the west coast. They run the funds as fiduciaries, and they aren’t firms that have 200 mutual funds to run. They might have four or five, six, something like that, and so they can do it that way, the International Stock Fund and Domestic and so on. So they can do that.
And another firm that I certainly think highly of is T. Rowe Price, who’s having a very good performance streak at the moment. It won’t last forever, I’m sure, but they could so easily reduce their management fees, because they make an awful lot of money, and instead of keeping it for themselves, the management company and its officers and publics, they’ve got public stockholders, and it’s the “no man can serve two masters” again.
I tell the story in my book about, let me say, 15 years ago I wanted to keep my tab, my eye on certain mutual fund companies that had public stock, so I bought 100 shared of T. Rowe Price for $4,000. Last year, I got a dividend from T. Rowe Price of $4,200. This is a profitable business. The capital value of that little investment is probably $350,000 now, and that’s great for the shareholders of T. Rowe Price, but if some of that money had gone to the fund shareholders, their performance, which I want to emphasize has been good recently, would have been even better. So the conflict comes up again and again. So the Adam Smith solution is moving your money to people you can trust.
CONSUELO MACK: So Jack, in fact, and you and I have talked about this before, investors are making decisions, and they are moving. They are voting with their feet, and they are moving from actively managed funds to index funds, passive funds, an industry that you created. So tell me about that movement, and what that is telling you.
JACK BOGLE: Well, it’s absolutely stunning, because in the last six years the industry has had $200 billion taken out of equity funds. Okay? That consists of $600 billion going into index funds and $800 billion going out of actively managed funds. That is a tsunami. I hope I got that one right.
CONSUELO MACK: You did.
JACK BOGLE: That’s a tsunami.
CONSUELO MACK: So fees really matter a lot.
JACK BOGLE: Fees. The correlation. The one thing everybody agrees on is costs matter, and even Morningstar, the eminent mutual fund rater, says that if you just look at a fund’s cost, you’ll do a better job in selecting future winners than you will if you follow their somewhat complex recommendations. So that’s a concession, and that’s good on their part, because it’s true. So that’s the Adam Smith solution. Investors act. The invisible hand changes the system.
CONSUELO MACK: We spend a lot of time on WealthTrack identifying active managers who are invested in their own funds, who put their shareholders first because they’re shareholders, too, and who have a history over the long term, let’s say 10-year compounded returns, of outperforming the market. So in the one area of human endeavor, why do you think that we can’t expect some human beings to do better than the market over the long term? Why exclude them?
JACK BOGLE: History is not kind to that idea, and a big part of my new book is about reversion of the mean, the fact that above-average managers become below-average managers and then average managers, and I have eight charts in the book, and I compare the cumulative return of the eight major big performing funds over the last... of the modern era really, with the S&P, Standard & Poor’s 500 stock index, and every chart looks like it could be laid on every other. Beating the index, beating the index, beating the index. Losing to the index, losing to the index, losing, and ending up exactly even with the market.
This is an expectation, and actually they’ll often lose because of the costs, but the pattern, when you go through that chapter of the book, you’ll say, “I’ve seen this somewhere before.” So it’s hard to pick managers in advance, and part of the reason it’s hard is we look back and say we expect managers to do in the past what they’ve done in the future, and that becomes somewhat ridiculous for almost everybody. We kept the.. let’s see, the April 2000 edition of Money magazine, and it was laced with ads saying, “Our five-year average return is 43%,” or “We earned 105% in the era of the great boom in technology stock.” I think the average gain over the market was maybe, say, 30% a year. Thirty percent a year, and five years later those funds had all gone down.
CONSUELO MACK: Reversion to the mean.
JACK BOGLE: Reversion to the mean and below. Well, these were hot funds, and they just go. You know, they’re on a very bad track, and so they go out of business, and what a lot of people don’t realize when they look at history, they say, “Well, mutual funds haven’t done that badly over the last 10, 15 years.” Half of them have gone out of business. You don’t see their records. You see the records of the other half that are surviving. Survivor bias, and so you think, pretty good industry. Well, not if you look at people were investing in 100% of the funds. And that’s a mathematical fact.
The markets are quite efficient, not perfectly. Managers compete with each other. They all believe they’re above average, naturally. They all believe they can beat the market, but the reality is that over... mutual fund managers are, by definition, average. They have to be, because they own all the stocks in America as a group pretty much, and so if somebody’s winning, somebody else is losing, and to make matters worse they’re losing. Some win and some will lose, but that’s when you look at the returns before cost. Look at them after cost, same pattern that I described earlier. So you know, it’s nice to think we can pick good managers. I hope your guess proved to stay the course and win, but I’d just check them out a little bit every five years is all.
CONSUELO MACK: Right. So talk about this speculation that you’re talking about inThe Clash of the Cultures: Investment vs. Speculation. What is the speculation environment that you think is so damaging to individual investors, and what’s your evidence that it is so damaging?
JACK BOGLE: Well, of course, there’s plenty of evidence. I mean, the stock market, when I came into Wellington Fund, was probably trading five million shares a day, and today it’s trading, I don't know, six, seven, eight billion shares a day, depending on the day.
CONSUELO MACK: And what’s wrong with that? I mean, why is that bad for individual investors?
JACK BOGLE: Well, what it means is, I mean, you don’t have to participate in it. That’s the beauty of an index fund. But it means that investors’ trading costs alone are going to cost probably somewhere between half a percent a year- just the turnover cost.
CONSUELO MACK: I see.
JACK BOGLE: And one and a half percent, and then to get these great managers, you’re going to be paying them an average of probably one and a quarter percent, something like that. So all of a sudden you’ve got two percentage points out of your return just out of cost, many of which are generated by high turnover. Mutual fund turnover, when I came into this business, was about 18% a year. Now it’s 100%, so it costs them, but it has to cost because it obviously- think about this for a minute- there’s no basis for investors to win if I’m trading all the time with you, because your fund is going to win or lose, or my fund is going to win or lose, but the net value created is what’s siphoned out of that by Wall Street, the great croupier of the market casino, and so there’s just no way of getting around that.
Now, let me give you another, in a way, more poignant and broader example. Everybody agrees that I’ve talked to and everybody that knows anything about economics and people in the business. Lloyd Blankfein of Goldman Sachs, if I can use him as an example maybe reluctantly, agrees. Mary Schapiro, the same thing, the chairman of the SEC, that the function, the principle function of the financial markets is for them, what I call the financial system, to provide the oil that greases the wheel of capitalism. So let’s think about that. We’re supposed to be directing new capital to its highest and best and most profitable uses, and we do that at Wall Street. Each year, about $250 billion- Wall Street raises about $250 billion- to direct to the most promising companies either initial public offerings or secondary public offerings each year, and that seems like a lot of money. So we’ll call that investment. And you say, “Well, that’s not peanuts.” In fact, it is peanuts compared to the amount of speculation in the market when we trade, gamble, speculate; that’s all it is, trading stocks with one another. They don’t go anywhere, and paying off the casino croupiers, we do $33 trillion. So what this means is, if you want to look at it in a rather harsh, mathematical way, that 99.2% of what Wall Street is doing is speculation, and 0.8 percent, less than one percent, is long-term investment.
CONSUELO MACK: In your book,The Clash of the Cultures, you have 10 investment rules for individuals. Time is your friend. What do you mean by that?
JACK BOGLE: Think of the value of compounding. Get yourself out a little compound interest table and see that at seven percent money doubles every 10 years, and then it doubles again, and then it doubles again, and then it doubles again and doubles again and doubles, and by the time you’re at retirement age, if you start investing when you’re 50, it’s multiplied. You’ll have to tell me, but let me say 35 or 40 times over. Unbelievable. Maybe even more than that.
CONSUELO MACK: Three: buy right, hold tight.
JACK BOGLE: Okay, buy right, hold tight means don’t make mistakes at the start. Pick a good fund and hold it through thick and thin, and I would argue very strongly, if you’re looking at an actively managed fund, and you should be very careful to buy the low-cost ones even if it’s actively managed, don’t get despondent when it does badly, because it comes and goes.
CONSUELO MACK: There’s no escaping risk.
JACK BOGLE: Think about that for a minute. I don’t like the risk in the stock market. So put your money in a savings account, a certificate of deposit. There’s no risk there… wait a minute. The return there is probably going to be about one and a half percent, and we’re going to have two and a half percent inflation. So the real return is essentially, and this has been true all over history, that the return on a savings account, the real return, the nominal return of, say, one and a half percent at the moment, very, very low, turns into a real return of minus one percent.
CONSUELO MACK: Forget the needle, buy the haystack. You buy the whole market. Why?
JACK BOGLE: Yeah, well, because buying a good manager is like looking for a needle in a haystack. And everybody knows what that’s about. Good old Don Quixote had it about right, and so it just makes common sense. Own the whole market and not just a few stocks. You don’t need to take the risk of individual stocks. Take the market risk which is quite high enough. You don’t have to take both.
CONSUELO MACK: The hedgehog beats the fox.
JACK BOGLE: The fox knows many things, but the hedgehog knows one great thing. And in our business, the foxes are all those managers who are smarter. They’ve got all those computers, all those brilliant Harvard Business School graduates, armies of them, and they know everything. They know far more than I could dream of knowing. I know one great thing, and that is if you own the market- which they do collectively, naturally- if you own the market, you are guaranteed, in a low-cost index fund, you are guaranteed to earn your fair share of whatever the stock market is kind enough to give us and, let’s be very clear on this, whatever return a bad market is mean-spirited enough to take away from us. So it’s the hedgehog who wins, and the poor fox with all of his wiles and his marketing department who figures out what everybody wants, all those crazy things that go on in our business- he’s yesterday, and he’s going as fast as I can get rid of him.
CONSUELO MACK: And your final rule for investors is: stay the course.
JACK BOGLE: The markets are really- just think about this for a minute- really counterintuitive, because when do you feel you’re most optimistic and most happy and enthusiastic about buying stocks? At the market peak. When are you scared to death about stocks and really want to get out? At the market bottom. So you get in at the top and out at the bottom. Do you think you’re going to do well doing that? So figure out a sound program, set the right course and then don’t let all these superficial emotional momentary things get in your way. Another way of putting it is, don’t do something, just stand there.
CONSUELO MACK: So Jack, the One Investment that we should all own in a long-term diversified portfolio, what would you recommend that we all own something of?
JACK BOGLE: Total stock, total U.S. stock market index fund. Period.
CONSUELO MACK: And I have to say, Jack Bogle, you are an investment giant, you are a tireless advocate for the individual investor, and I can’t thank you enough for staying the course throughout your many decade career. We are all the better for it. So thanks so much for joining us on WealthTrack.
JACK BOGLE: I love your closing line. And thank you. It’s great to be with you.
CONSUELO MACK: At the conclusion of every WealthTrack, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is a no-brainer. It is: read Jack Bogle’s new book,The Clash of the Cultures: Investment vs. Speculation. It represents the professional and personal philosophy and history of one of the all-time investment greats. No one has fought longer or harder to return the investment profession that he loves back to its fiduciary, investor-first roots.The Clash of the Cultures is destined to be another Bogle investment classic.
Next week, as public television embarks upon its winter fund raising campaign, WealthTrack might be pre-empted in many markets so we are going to revisit our two part series on impact investing: how to match your investments with your values with advice from two socially responsible investing pros. If you would like to watch this program again, please go to our website, wealthtrack.com. Premium subscribers can see future programs 48 hours in advance, and additional interviews with WealthTrack guests are available in our WealthTrack Extra feature. And that concludes this edition of WealthTrack. Thank you for watching and make the week ahead a profitable and a productive one.
