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John Bogle Has Had Enough

Enough is the title of his latest book, but it's also his state of mind--given all this talk about the death of buy-and-hold.

David J. Drucker, 05/27/2009

John C. Bogle should be a household name for those who would read this article but, in case it's not, here's a little background.

Bogle, having just turned 80, founded The Vanguard Group--one of the two largest mutual fund organizations in the world--in 1974. He has won numerous awards, including recognition as one of the investment industry's "Giants of the 20th Century" (Fortune, 1999) and "One of the World's 100 Most Powerful and Influential People" (Time, 2004).

But his viewpoints--well-known to most in the financial services industry--set him apart far more than his awards. The name--John Bogle--is almost a proxy for the investment style he has touted throughout most of his career: buy and hold index funds. Why buy and hold? Because short-term trading is a sucker's game, and because index funds impose the lowest costs on investors, says Bogle. And the Vanguard Funds are a living testament to the fact that mutual funds can profitably serve investors with low-cost, client-first products.

Drucker: While growing to its present 14% share of the mutual fund marketplace, Vanguard's message has been to 1) eliminate conflicts of interest with shareholders, 2) own the entire market via the right asset allocation, 3) don't peek at the results, and 4) you'll be all right at retirement. My question is... has Vanguard's unique path and its own success influenced other mutual funds to follow suit?

Bogle: Since Vanguard's conversion to no-load in 1977, that arm of the mutual fund marketplace has become more dominant. On the load side, all the tricks used in the past to hide the load--such as Class B shares--seem to be vanishing. Initial sales charges of 7.5-8.5% have leveled off at 5%. This is partly a recognition that consumers are more cost-aware and that an 8% load is an awful lot of money. But I wouldn't give Vanguard too much credit for driving down costs when there are still products like variable annuities with much higher costs than load funds. However, when other funds try to compete with our index funds on the basis of cost, that's clearly a result of what we've done. Vanguard is a low-cost producer at 20-25 basis points, while other funds think they're low-cost at 75 bps.

Drucker: How, then, should we interpret Vanguard's move into ETFs? Are you hedging your bets should ETFs outpace mutual funds in the future?

Bogle: Everyone seems to have forgotten that ETFs are mutual funds, so how can there be a conflict between the two? The only difference is ETFs can be traded all day long--a big negative for investors. If you don't trade them or buy the highly specialized ETFs, they're good investments. But the idea of using ETFs to segment the market and play industry sectors like stocks strikes me as a formula for loss. The first ads for SPDRs said, "Now you can trade the S&P 500 all the time at any time." My reaction was, "What kind of lunatic would want to do that?" I like the idea of spreading [the wisdom of] indexing and ETFs have spread it widely--as long as they're used as investments and not speculative vehicles. Short-selling leveraged ETFs plays on the worst instincts of investors. Non-market-cap-weighted funds are a marketing gimmick. But [these speculative] strategies are well suited to ETFs because ETFs are "hot" and because brokers can trade your account all day long using ETFs.

Drucker: In the market decline with which we're now struggling, few mutual funds are enjoying positive returns. Does this cast doubt on the buy-and-hold index fund approach you've championed for so many years?

Bogle: I read all the time that investors need to move beyond a buy-and-hold strategy, but this strikes me as being a dumb idea. What is the advantage of swapping stock with other people? The stock market system is based on the idea of pitting the interests of one investor against another, knowing that only one will win. People say it's a stock-pickers market but, if your stock picker is good, then mine is bad. It's all a gimmick. Of course buy and hold is the thing to do. A genius like Jim Cramer hasn't gone anywhere for 10-14 years and few [managed] mutual funds have beaten the market indices during the same period. It's just market timing, and your good market timing is my bad market timing. [We invest within] a totally illogical system where we move money around and the middlemen--or what Warren Buffet calls the "helpers"--are the only ones getting wealthy.

Drucker: What we haven't discussed yet--which in your philosophy of investing seems to be the third leg of the triangle--are the costs of stock picking.

Bogle: I'm unhappy with a financial system that ignores the costs of investing, and we do a poor job of communicating these costs. We all know what management expenses are and can compare funds [on that basis], but we often forget about sales loads, expense ratios, and turnover costs, all of which may add another 3.5% a year to a fund's expense burden.

Drucker: I asked you earlier how Vanguard's adoption of your investment philosophy has affected the competition. How about in the expense area?

Bogle: Vanguard is always near the top in performance and it's always the lowest cost, so you would think that with 14% of the marketplace and our performance and our shareholder trust, somebody somewhere might have said, "These guys are eating our lunch, so why don't we copy them?" But it's not that simple because they'd have to operate economically, cut out their marketing and operate without profits. [Vanguard operates at cost since its fund management company is owned by its shareholders].

Drucker: Tell us about your book Enough (Wiley, Nov. 2008)--what is the main message?

Bogle: This is a book I wanted to write very much because I'm worried about our society going down the wrong road. The book makes the point that a financial system that takes too much out of investor returns doesn't create additional value. We want to beat the market but will inevitably fail because of [transaction] costs, so I question our values and what is really enough.

Drucker: In an article you recently wrote entitled "Six Lessons for Investors," you said: "Beware of financial innovation." This seems counter-intuitive. Don't we need financial innovation, for example, to come up with products that can give the common man greater assurance that his hard-earned savings will get him through retirement? Or do we just need to be wiser in our use of tried-and-true investment products?

Bogle: I saw a great ad for shredded wheat the other day saying things like, "It's been made the same way for 120 years" and "We put the 'no' back into innovation." We know that in our financial system, winners will offset losers. So the simple route is to drive costs out of the system and capture as much of the market return as possible. This is available to anybody through the ultimate innovation--indexing.

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