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Bogle on Fund Industry Progress and Imperfections

Wed, 17 Jul 2013

The Vanguard founder offers his thoughts on the need for money fund reform, the dilemmas with retirement planning and savings, the fiduciary duty of fund managers, and much more, in this video exclusive to Premium Members.


Video Transcript

Don Phillips: Let's begin with a couple of hot topics in the industry. One of the things that has been on a lot of people's minds recently are the money market reforms. I'd love to get your sense of just how grave is the problem, the threat that money market funds might present to the financial system? And what do you think are the solutions that have been suggested, and are they the ones that you would advocate?

John C. Bogle: Well, it's really interesting when we talk about probabilities and risks and things like that. Because the probability of something happening bad in the money market business is tiny, but the consequences of that going wrong--as it did with a big institutional fund run out of New York, I guess eight to 10 years ago--is fatal. The U.S. Treasury had to come in, back up the money market funds and backed up every single one of them, which was an interesting kind of step. But now Congress has decided no more tax-payer money to bail out the money market fund industry. It seems like a reasonable position to take. Tax payers are bailing out everything else, but we might as well draw the line in a profit-making business. So the consequences are dire, but the probability is tiny.

I think we still must act. And what bothers me, and this bothers me a lot about the industry in which I find myself--you know I have a lover's quarrel with the fund industry that I loved for 63 years now--they don't seem to like to get right down to the truth.

What's the fact? The fact is that money market funds' net asset values fluctuate. What's the industry's problem? They don't want to let the world know that money market fund asset values fluctuate. So, I think they are leaning on kind of weak reed to fight against having, say, a $10 asset value that will go to $9.99 or $10.01 whatever it does in fluctuation, not large. And of course this industry, which is well, the technological Vanguard of just about everything, they can do anything, but they apparently can't deal with a single class of funds that has a floating net asset value. That seems a little kind of crazy to me.

So, I think the industry has got to stop defending its own financial interests and start thinking about the interest of shareholders and letting them know actually how money market funds work. I don't like the reserve solutions that they proposed, having the funds hold the reserve; I wouldn't even know how to do it from an accounting standpoint. But having a floating net asset value, say $10, and you can hold the $10 if you really want to be conservative, that's up to the money market manager. But having that as the solution.

Now what the government has decided to do or the SEC is recommending, it's not done yet, is to have asset values float for institutional funds, where the largest problem is. That seems to me like a King Solomon type decision, cut the baby in half. I think they should either do it or not do it.

In my reputation, which is mixed, one thing that people rarely call me, like they call, I think, [U.S. politician] Henry Clay, the Great Compromiser, and I don't think we should compromise. I think we should be straight-up, upfront and do the thing that we know is true. And I should say this, insulting myself a little bit or maybe more than a little bit, I thought the $1 asset value was crazy from the day the business began. So I go back a long way on this, maybe 1974.

So I started our Vanguard Money Market fund with a $10 asset value. So, it kind of has come full-circle for me, and it was totally unmarketable and ignored. Nobody would use it. Everybody wanted the dollar. So I caved, and I've told people the consequences were not dire in that case. But every time I did something for marketing reasons, it was going to be in that long, long list of things that I never should have done. Don't do things for marketing reasons is my lesson in anything you do. And I've done too many things that way. I haven't done it for a long, long time because I learned. But we really ought to be thinking about the shareholder and about the society, not having the Treasury bail us out all over again. Did I make my position clear?

Phillips: Absolutely. Now, one of the claims I've heard from some of Vanguard's competitors over the years and regarding the money market funds, they said, "Look, if in our own money market fund we had a substantial loss, we could take our profits from somewhere else and make the money market fund whole. But Vanguard, they're playing without a net because of their mutual structure. If they had a default, you, the investor, would be stuck with it." Now, clearly, we have a long history though, and Vanguard has never stuck anyone with a loss there, but what do you make of that argument?

Bogle: Well, it's a good argument. I mean, we've had in the old days a thousand times over what would we do if that happened? You try and look at the possibilities and the consequences again, and the probabilities and the consequences, and we could do one of two things. [We could] let it go down, on the one hand; try and create some kind of reserve at Vanguard, but it's very hard to do from an accounting standpoint. Or just have the other funds chip in. That sounds kind of outlandish to have the shareholders of Wellington Fund or Windsor Fund or Index 500 be assessed a miniscule amount of money, but nonetheless be assessed that money and bail the fund out. I think some of the competitors made a big thing and we couldn't do it. Of course, we could do it.

We pool our resources for marketing; we pool our resources for administration; we pool our resources together for Vanguard and share the resources for a shareholder record-keeping. So there's no reason we can't do it, though, I think people would look at this rather differently. So, I would say that the premium on us is to make darn sure that none of that happened. Therefore, you're going to find in our Vanguard Money Market fund, probably the highest quality of any money market fund out there, which we can afford because if your competitors are running their money market funds at 50 basis points and you're running yours at 20, you got a big premium in there.

So, it's not an easy thing to do. It would be very unpleasant, but I wouldn't worry about it. To which I would add, the competitors that say these kinds of things are probably, let me say, have capital of $50 million or maybe $500 million. If they're going to run on their money market funds and they're big funds, that's not nearly going to cover the bills. So, they're going to have the same problem, only in a sense even worse. So, you hope it won't happen. Hope for the best, but be prepared for the worst.

Phillips: Jack, last question on money market funds, I promise, but how come you can get the expenses on a stock index fund down to 5 or 6 basis points, but a money market fund only to 20?

Bogle: Well, check-cashing is a simple answer. They require a lot of administrative processing. And I should tell you that in terms of full disclosure that when we started Vanguard, we agreed to a self-imposed formula for allocating expenses from one fund to another to one fund or another. It had to do with investment activity, shareholder activity. We can get to the length of each phone call, but all the things that you could attribute and then like direct overhead, indirect overhead, and that kind of thing and direct costs, and that was the way we cost out everything.

A long time ago, 1993 was the year, I decided we shouldn't be in that kind of a box. We ought to be able to price to meet competition. And we put out a proxy, shareholders approved it. Fidelity did not. They wanted a hearing and didn't get it. But we could defend our position I think.

So now, we can price to meet competition, and we do it to some degree. I don't run the books anymore, but it's a number that is partly cost-based, but partly judgment-based and partly competition-based.

Phillips: Jack, let's turn to the retirement crisis or the retirement issue in the United States. When I look at 401(k) plans over the last several decades, I see much progress. I see less money in company stock, fewer people in their 20s with 100% in stable-value holdings, and more money in balanced funds, things like target-date funds, auto enroll, and auto increase. In other words, I see a lot of progress. But a recent Frontline special, which you were featured in, was sharply critical of the industry. I'm interested in how do you score the progress, how big is the crisis, and what still needs to be done?

Bogle: Well, we have, as I wrote in my most recent book last summer called The Clash of the Cultures: Investment vs. Speculation, the retirement system in the U.S. is facing a train wreck or to be more specific facing three train wrecks, all of which have to be fixed. You can't be on this track to a wreck and not do something about it. You got to do something about it before it gets here.

Social Security, you all know about that. It's just underfunded. It could be funded with things that people wouldn't even notice, a change in the cost-of-living adjustment which the administration has proposed. And there are simple things that end up being completely controversial. And you become a little bit cynical when you have been in the business as long as I have. But the reality is that that would be a fairer way to run the Social Security, to do the cost-of-living adjustment. It's now wage-based, and it should be Consumer Price Index-based. So you get an extra bonus for the way it's calculated. So I'm in a sense not proposing reducing the payments, but making the payments appropriate to circumstances. That alone and a little older retirement age, a larger minimum Social Security distribution, larger wage for that, and the problem would be solved.

I was on a panel not so long ago with [former Fed chairman] Paul Volcker, and I said, "I could solve this. If I were the czar, I could solve it in five minutes if you get the politics out of it." And I said, "If Paul were with me, we'd actually get the things fixed immediately." And Paul looked to me and said, "You mean, we can't fix everything?"

Well, you need people to stand up and be counted. I don't have anywhere near the kind of respect he has in the financial circles, and the administration and with both political parties. But it can be fixed, and all it requires is political will.

The defined-benefit plan, which is the vanishing figure in the overall retirement system, is grotesquely underfunded. These firms are gradually reducing in the states. The states are a bigger problem than the corporations. They are using an 8% future return. I will say unequivocally, they're not going to get an 8% future return. Not with bond interest rates around 2% depending on what you're looking at, the 2.5%. And stocks will likely return about 7%, and that's before costs. And the way these corporations and states look at it is in effect they say and they've said this to me, "You know, you're right about the return, but we're going to hire good managers, hedge fund managers." It's possible for any one of them to do that, but it is impossible for them all to do it. The reality of the markets is the reality of the markets. So, they're going to have to start getting bigger contributions, particularly in the municipal-bond and state and local government area, and corporations, too, but they are so dwindling that they're, I think, not a major thing on the horizon.

The one you asked about, the third leg of this retirement stool is the defined-contribution plan, and the problem with it is we've taken a thrift plan and turned it into retirement plan. The 401(k) is a thrift plan, a thrift savings plan.

The federal government actually calls theirs, and that's one of the best ones out there, the thrift savings plan. So when you try and make it a retirement plan, you have to do things that I would do when it needs to be fixed. I'd be much more strict on withdrawals. If you allow people to say, "I've got a sick child and my wife wants a new living room rug and I need take some money out," you take it out. How are you going to ever have a good retirement doing that? What would your Social Security benefits look like?

Social Security wouldn't amount to anything if you take your money out whenever you felt like it. So it's too much ease of access. If you change jobs, you can [withdraw from your retirement plan]. It's just a system that has too much flexibility, and of course, I can't resist saying as I told them on the Frontline interview, that they're investing in the wrong thing. That is, what do we know about all of these thrift plans, 401(k) plans, mutual fund plans put together? We know they are indexers because they own, as a group, the entire market. There is no way around this, and if you look at what they have in all those plans, it looks just like the market. It probably has an R-square of 99, something like that, maybe even 100. So by owning the market individually, they're assessed these substantial costs:1% say for the fund, fund turnover costs at 0.5%, extra charges by the companies or by advisors or whatever it is that have replaced brokerage loads, and it comes to maybe at least 2% a year total all in costs.

So, they're going to get the market at 2%, and as economist Bill Sharpe said in an article in a recent Financial Analysts Journal, just using 1% you're going to end it up with 20% retirement income, less than people that just own the index. As an example, he happened to use Vanguard Total Stock Market fund, I think with a 6-basis-point expense ratio.

So, the math is undeniable. So, we need more discipline, we need less ability to take money out, and we need investors to do the right thing in terms of their investment choices. How do you mandate that? I mean, you can't say, though some people that are knowledgeable in the industry have said, "Just make index funds mandatory." Well, we have so much money rolling in, I'm sorry to tell you that I'm not even so sure I'd be happy about that, maybe somebody else's index funds.

But index funds that are low-cost, and Don has pointed out this any number of times, an index fund isn't any particularly good if it's high cost or it has a sales load, and the loads are gradually being shifted to different forms. It's got to be a low-cost index fund. So, what I've recommended in my book is that we have a federal retirement board that determines eligibility for a firm to get into the retirement plan system, guidelines for long-term focus, prudent-man kind of stuff, reasonable fees that would have to clear muster. And it should be, I'd be the first to say, a fairly reasonable bar. They can't cut it to Vanguard's level because nobody can match that. Too bad for them, nice for us.

So it's basically getting the costs out of the system and getting discipline into it.

Phillips: Jack, you mentioned the high costs and the problem with the choice. And yet when I look at the industry, most of the money today in 401(k) plans is going into target-date funds. The three big providers all have costs substantially lower than what you cite, and there is a trend a lot of that is in Vanguard's target-date funds which have index funds. Fidelity has an index target-date, Charles Schwab has an index target-date. Is the market to some degree taking care of this problem, and what do you think of target-date funds?

Bogle: Well, my first impression about target-date funds, I mean it just follows kind of the philosophy I've had as long as I can remember, and that is your fixed-income position should have something to do with your age. The target-date funds are all based on that. I am not sure, and I guess this is almost a postscript before I get to the main point, but I am not sure we don't have to think a little bit about whether that idea works under all circumstances.

You would think it should, but does same rule prevail when bond interest rates are 7% and prospective stock returns are 12%. It does when interest rates or bond market fund I think the yield is around 1.6%, 1.7%, very heavily in Treasuries, which I have my doubts about in terms of that big a position, not zero, but 70% is too much. And should you think a little bit about the relationship between stocks and bonds when there gets to be a lot of disparity?

Generally speaking, try not to put yourself in a position of having to make judgments because they are so often wrong. Nonetheless, there are moments in time when you might at least say, are we doing the right thing? Is this strategy, which is bringing in the money day after day after day, still right? It was right, sure, and everybody is looking back and it worked fine.  So there is a little bit of nervousness about target-date funds and the way we do it even though it's fundamentally the idea I probably had earlier perhaps than anyone in the industry.

The other thing that worries me, and Don and I talked a little bit about this yesterday, is I think target-date funds have too narrow kind of a mandate. Think about it this way, virtually everybody who is investing has the resources to invest for their future, and probably a third of the citizens of this great country or a third of the families do not have those resources and will never have them. They will have to rely totally on Social Security. But once you get Social Security, think about how that fits in to target-date environment.

You can do this a lot different ways, but let's suppose that the capitalized value of Social Security at age 65 for most people is, say $300,000 to $350,000. Let's use $300,000. And it's going to be exhausted at the end of life expectancy; you will still get it but somebody else of course will have died, bless them. So you've got a $300,000 fixed-income position and probably the best fixed-income position you will ever have in your life. It's got a cost-of-living adjustment; the payouts are good. The payouts are as close to certain as things can be in this world. So you're sitting there with that $300,000.

Now let's look at you've accumulated $300,000 in your investment side, your personal portfolio or in your 401(k) plan. So if a 100% of that is in equities, you are 50-50. You should look at that. I'm not saying you should forget the age-based solution, but you should think about what other sources of income you will get during your retirement rather than basically treating target-date funds as your entire asset base. Because for probably 90%, 95% of all investors, it isn't their entire asset base if they would look at Social Security. The other thing, Don, let me add parenthetically, is this gives me an opportunity to make my other idea about retirement clear. That is, we're all transfixed with the movements of the stock market; up and down, up and down, up and down, when that has nothing to do with your retirement, zero.

What you should be looking at is the stream of income, and if Social Security is paying you, let me say, $25,000 a year, whatever it might be, $25,000, $30,000, whatever it is, you should be looking for the other side of the portfolio to produce a stream of income. And as long as you get those checks, your retirement plan is unaffected. You don't care whether it's worth a lot or a little as long as the checks come in. And if you look at it, probably the greatest single durable part of our stock market is dividends. They go up virtually every year and have been doing that since 1925 when they started keeping the data, with two exceptions.

One was the Great Depression, when they probably went down 50%, and the other was in 2008, when they went down 22%, by far the largest drop in the S&P dividend going all the way back to the 1930s. I don't think that's likely to happen again, but it could, always could, anything can happen. But that was a big drop, and therefore that would have affected the payout and your check would have been smaller. Even if you lived through that or expected it to end, it's not going to be easy for people to handle. But they just look at the stream of income, which would suggest more focus on dividend-paying stocks and less on growth stocks--and I know that's kind of almost a fad these days and therefore maybe overpriced--but in the long run focus on the dividend stream, focus on the fact your Social Security checks will keep coming in and grow each year as inflation grows and think about your retirement in terms of when you go out that little old mailbox pull out two envelopes, your fund envelope and your government envelope and maybe another pension plan or something, whatever there is, and that's what should matter to you in retirement.

So, I think it's change in mental attitude, it's change in not giving away quite so much money to the managers who have trouble obviously earning it. So, that's the direction I move, and it's easy to paint the big picture as I have done, and it's pretty simple. But the detail, above all these things is murder, like it always is.

Phillips: Jack, we should note that on both money market funds and the retirement crisis that your views differ rather dramatically from the current Vanguard management team, who wanted a steady $1 net asset value, and issued a report saying that things are much better with the 401(k) system than people recognize. What would you say to people that say, "Vanguard gets to be on both sides of every issue. Jack comes out and makes the populous statement that gets quoted in The New York Times, but shareholders in Vanguard funds are actually paying for Vanguard's management to be working vigorously behind the scenes in Washington in pursuit to the exact opposite outcome."

Bogle: Well, there is a little matter of phraseology here, Don, and I've been asked many times, "I understand you disagree with Vanguard on this point." And I'd say, "Absolutely not, I would never do that. Vanguard disagrees with me."

I've been in this business, I am too old to go out and speak vigorously in favor of a position that I simply don't believe fundamentally in. And so it gets me in a little bit of trouble, that will not surprise you. I never know to be honest with you, what Vanguard's position is on these things. I mean I probably have an idea, but I have my position. I might take it before Vanguard does, I might take it after. I still think it's important to have somebody like me who's been around this business--you can ask me whether I'm bragging or complaining--longer than anybody I think in the whole business thinking, you have to stand for what you stand for.

And the book that I mentioned Clashes of Cultures, Vanguard was not particularly happy with that book. I believe that the mutual fund industry owning 35% of all the stock in America, and actually, and this is an important side point, much more than that because there is not a single one of the 25 largest mutual fund managers that doesn't run institutional money. No single largest manager in America, the states fall below that, that doesn't run both institutional money and mutual fund money. If you add together the money managed by those 25 large firms, it's probably 50% of all the equity in America.

A small handful of corporations, particularly the top five of them, control corporate America. And corporate America needs a lot of cleanup, a sweeping out. Executive compensation is a disgrace. Political contributions made by corporations are a disgrace at least until the shareholders approve it. And I had a proposal out there that didn't go very far; it said corporations should be able to give nothing to charity unless the shareholders approve that gift of corporate assets for charitable purposes. And for any kind of purposes, any kind of a gift should not be allowed by the corporation, because they do it usually in their own executive self-interest or feelings of what's best for the company. And sometimes that's good for society and sometimes it's not.

So when you look at the whole picture, really we're the last gatekeeper. Think about that for a minute; I have a chapter in the book about gatekeepers. We're the last gatekeeper. We, the mutual fund industry. The courts have failed us in terms of shareholder rights. The regulators have failed. The security analysts have failed. The money managers have failed. Right down, the press has in many respects failed with a few exceptions. The fund and corporate directors have both failed, and we're now down to the last line: the shareholders who own those companies. And if they don't speak, there's nobody left, and corporations should not be left to operate as private fiefdoms of their chief executives.

Phillips: It does seem a great missed opportunity, the opportunity to be the voice of the small investor to corporate America that the industry has essentially punted on.

In a number of your books you've talked rhapsodically almost about the camaraderie of the early days of Vanguard, I think invoking Shakespeare, Henry V: "We few. We happy few. We band of brothers." To what degree does it pain you to be estranged from the current Vanguard management, or for the current Vanguard management to be estranged from you perhaps?

Bogle: Yeah, they have a difficult problem, the present management. "Here is this old guy who keeps saying what he thinks."

Phillips: That's dangerous.

Bogle: "Would he just shut the. . ." And I understand that. What I don't quite understand is the creator of the company would normally own every share of stock in the management company, and then there would be no disagreement between me and the management. That was not our case, but I do think that a company where it's actually quite a remarkable story filled with luck, chance, determination, fights, battles, all those things that go into it, almost every one of which, by the way, I loved them--I just like a fight. "Bogle, get out of the picture; get out of the ring."

Phillips: The competition is to really spur you on.

Bogle: Yeah, exactly. So it's the way the world works. Human beings are, dare I say, noninteresting in the way they react to things, and sometimes the creator of all this gets a little bit lost in the shuffle, in other people's ambitions or egos, and it's OK. I mean, that's life. But you might wish to be a little bit different. There is no way to change it, so you just face it with good humor and a smile, number one, and except what can't be changed, and just go out and do your best. I still feel very good about, when we started Vanguard, we had 28 crew members counting me and talk about that good old days. We had no committees. No one discussed corporate strategy. I'm not sure I even called it corporate strategy. But I knew what we had to do, or thought I did, and it worked out OK. I was interviewed for something and they said, "What do you think about teamwork?" I said, "It's probably the most important thing that goes into the operation of any organization; governmental, nongovernmental, corporate, whatever, but I am terrible at it."

I guess we are who we are, Don. So, I miss it. I do spend a lot of time, very enjoyable part of my time, because I'm still working harder than I expected to be, or working or playing--depending on what to call it--in the office every day, traveling a bit and less. But I still spend a lot of time with our crew. I met three new ones out there at our booth [at the Morningstar Investment Conference]. The veteran there had been there for six years and I'm thinking, wow.

But I like to try and get to know them in a company that inevitably is, as [Morningstar vice president of research] John Rekenthaler wrote recently, kind of a technological machine that knows how the system works and makes it work very well, all the record-keeping and all that. I don't like to think about it that way because to me human beings are the most important part of every single equation. I've been using that phrase as far back in my career as I can remember; human beings with whom we serve at Vanguard and the human beings whom we serve, our shareholders. And once you get big, it's hard to do, and in my 1999 book, one more plug, but very different book, Common Sense on Mutual Funds, brought out again 10 years later intact with updates, I tell a story. The last section of the book is called "On Human Beings." So I was up talking to a Harvard Business School class quite a few years ago, and someone said, I read your book, "Why on earth would you have a chapter about human beings on a book about investing?" And I looked at this young woman and said, "Who do you think we're investing a whole lot of money for?"

It's an attitude, and when we lose sight of it as a corporation, anybody does, and this is not pointed at Vanguard because it gets very hard when you get big for everybody. When you go from 28 crew members to 14,000, it's hard. So what do you do? You do your best. Spend time with everybody, one-on-one with a lot of people. Obviously I can't do it with 14,000. Do retirement dinners, 25-year anniversaries, assuming nobody else in the management is there, because I don't need to interfere with that, and try and keep a little human touch. It makes me happy, and I'm darned if I don't think it makes them happy, too, Don.

Phillips: I'm sure it does. Jack, let's turn back to the market-timing scandals in the fund industry, which are sort of a seminal event of the last few decades. Given what we now know about his strong-arm tactics, his disregard of due process, the fact that he lost nearly every case he actually took to trial, let alone his personal life, do you still think Eliot Spitzer is a true American hero?

Bogle: Well, just to be unequivocal about it, yes and no. The overreaching on the legal slide was not proper, not good. I could see a little bit of this, to be quite blunt about it, when I got to know him decently well, but not well enough to tell him to put the arrogance aside and if you want to take on Wall Street, don't take on John Whitehead, the most respected man in Wall Street, deservedly, former head of Goldman Sachs when Goldman Sachs was a little different than it is today. So on that, no, but for taking up this crusade on the mutual funds side, I think it was courageous. I think he did it energetically. If he overprosecuted some of those other cases, which I think he did, and it probably wasn't his fault, but he underprosecuted the mutual fund cases. In all that, only one person went to jail in all that mutual fund fakery. An absolute disgrace, a black eye for our industry. I looked at it as a conspiracy; my legal theory, I'm not an attorney. I looked at it as a conspiracy of fund insiders and hedge fund managers to defraud the long-term holders of the funds. A classic case of conspiracy, and that's what happened.

But, alas, I was nobody's legal advisor and the courts had a very high standard of proof. There were some fines. There were some suspensions from the business. One guy went to jail actually for not telling the truth, for obscuring the records. We had in those days this one particular guy who came to one of my book signings and I said, "Oh my God, I'm so sorry I called you one of the bad apples." And he said, "No, I was a bad apple. I did the wrong thing. I know that and went to jail, paid a penalty for it, and that was the right thing to happen." But this was a fund, and he would say, for the fun of it, a $3 billion fund that each year had $4 billion of sales and $4 billion of liquidations, no net capital flow. Could there be market timing going on there? Where were the directors? Did they not look at the financial statements? It's right there in plain print.

And that raises questions about the structure and the sense of fiduciary duty of directors. In a speech I gave in Boston very recently called "Big Money in Boston"--It's on my website, www.johncbogle.com. It's a pretty good talk--but I observed there what a failure we've made of fiduciary duty, and then I raised a solo question. Take Fidelity, or for that matter take Vanguard, we each run a couple of hundred funds. I think Fidelity runs 260 or 270, and Vanguard runs, I think, 160. Can our directors be fiduciaries and totally understand the workings of 160 or 260 different mutual funds? How can you be that kind of fiduciary when you've got 160 oversights? I leave that as a question, but the answer is pretty obvious. You need some help. You can't do it by yourself, and that's going to be an evolving part of this industry, where independent directors have an independent staff. I'm pretty sure that's going to happen.

Phillips: Jack, the fund scandal has clearly tainted the industry, and what a number of funds did was inexcusable. But is it fair to paint the whole industry with that brush? I think when the scandals first broke, one of the things that we said in the early days, where it seemed like every day another fund was being indicted, we said when the dust settles the majority of fund firms won't be involved and that many big players--we named names like Vanguard and Fidelity and American Funds and T. Rowe Price and PIMCO--won't be involved, and we were right about that.

To me it seems that clearly what happened was terrible, but there are so many examples of people who did the right thing, and almost all of the rewards have gone subsequently to those firms. And those firms that misstepped have been penalized severely. So, it seems to me in some way capitalism is working.

Bogle: Well, it sort of works, sure, I agree with that. But when you think about the way I think about it is, there probably were first only about maybe at most 20 mutual fund firms that were able to do this big market timing. You can't have billions going in and out of a $1 billion fund, but they're not big enough to be involved one way or the other. So, when you get down to 20 and take out the four or five you mentioned, which you're absolutely correct on, probably 100% of the remainder were in there and, say, 16 firms, I think that's about the number of big firms, and they have paid the price in the marketplace. But I think maybe the argument is a tad overdone, because someone like Putnam, which has had a real problem, a whole lot of ethical issues under its previous leader, two previous leaders maybe, is punished because they had terrible performance. So, you say, well, they got caught and the president had to pay a $25,000 fine. The guy made $300 million or $500 million running the firm for Marsh & McLennan and bringing in all that money, I would be glad to lend the guy the $25,000, I'll be honest. So, I don't think it worked quite as efficiently as you did, but obviously there was some efficiency in it.

Phillips: Reading some of your books it occurred to me recently that we all do a certain amount of anchoring. When you think back on the fund industry, you remember sort of a golden era of it being treated more as a profession, as a business back in the ‘40s and ‘50s. I started looking at this industry in the ‘80s, and when I look it seems to me that things have improved dramatically from the 1980s, when firms like Dean Witter and First Investors walked the earth and what were big players. But when you look back, you see maybe deterioration. Do you think that there has been progress in the last 25 years?

Bogle: Well, the key moment, I think, and many of these things are long forgotten, but the key moment in this industry that caused the turn from a kind of fiduciary notion--not pure, let me be careful. We weren't angels back then. But the Vanguard Wellington was one fund, and we and the directors certainly observed a fiduciary duty to one fund, that was what we had. And we're all schooled in the fund and knew what was going on. It was a small firm, and we definitely were doing our best to run it for the shareholders. And Walter Morgan was the owner and stockholder, as it was in those days; the partners on the investments side were generally the owners of the management company, privately held.

So that's changed. Public ownership was a big thing that came along in 1958. A court decision reversed the SEC ruling that you couldn't sell a fiduciary. All of a sudden now, 40 of the largest 50 fund firms are owned by financial conglomerates. I think that is a huge negative because they buy a firm like any corporation buys a firm, to earn money on their own capital and they are also fiduciaries to mutual funds and have a fiduciary duty to earn the maximum return on those shareholders capital and those things conflict at the level of cost. You can see it very clearly. So they've got dual fiduciary duty.

I said in that Boston speech, when that split is there, you go to good old Matthew 6:23--I always have a biblical quote--and that is "No man can serve two masters." And then Matthew goes on to say, later on, "You will either love the one or hate the other." It's very clear the master who is loved when a firm is owned by Deutsche Bank is Deutsche Bank. They are paying the bills or their subsidiaries' bills or whatever it might be, and that's where they look at their prime duty. They get the money and they are the master that is loved and the shareholder, I won't say the shareholders are hated, because obviously we all want to the best job we can within limits of the shareholders, but the mutual fund is at water's edge. We want to do the best we can for the shareholders, but we're not going to cut our fees.

Also, the other big change was the go-go era in the late 1960s when there were hot funds buying junk stocks. It's when institutional investing got popular for the first time in the popular press. Institutional Investor Magazine was created in, I think, 1966. And all these crazy funds came out, and they were doing the lion's share of the industry business. Go-go funds, Ivest Fund, the one I mistakenly got involved with. Fidelity Capital, Fidelity Trend. Everybody had to get into the go-go business and they all failed. They all failed. Some went out of business but they all had terrible records, when the great reckoning came in 1973, 1974 when the market dropped, yet one more 50% drop. I have seen three of them in my life, Don; I don't like them any better.

Phillips: Jack, objectively, when I look at the fund industry today, I see more good, low-cost funds available to investors than ever before. I see more examples of good stewardship, and frankly the funds that have low cost and good stewardship are the only ones getting assets today. Isn't that progress?

Bogle: Absolutely, let me say without any date, and you're right that the lower-cost, not low-cost because there is only one low-cost firm out there to be honest with you, and just look at the numbers.

But you know you can pick and choose where you want to have low costs, and the philosophy comes out if every fund in your complex has low costs. It doesn't come out when you can pick and choose to meet competition.

So I think there is some progress, but I don't particularly like the huge concentration of assets in the top five or 10 firms. It's actually higher than it was in the past, not hugely higher but those top 10 firms probably have 50% of the industry's assets, and that's where the money flows are. They are lower-cost. They are by and large better performers, and not all of them all the time. And we all have our errors and shortcomings along the way.

But I would say, yes, the industry is better. But what's that all about? We should be getting better and better from where we are, and that's really my gripe, my lover's quarrel with the industry. We can't stand there and say, "Well, we've done a great job," when the record shows that we have not done a great job, A because of costs, but B because of the way we attract investors. And you know, Don took this wonderful forward step of something I talked about and never did it industrywide, but Don did, of showing the difference between fund returns and investor returns and the gap between those larger funds of like 3 percentage points a year.

You have to just look at the larger funds because if they are not growing and have no capital flows, the two will be identical. So, larger funds have this gap 3% a year almost no matter what period you look at, at least 2% a year. And that says we're doing something wrong, somehow in the way we attract investors. And it's very clear that we add to their desire to have winning funds; that's what we advertise, even show performance for them. Even show the number of 5-star funds we have, which is my favorite ad, it says we have 48, 4- and 5-star funds with sponsor A, and I have 73 1- and 2-star funds. For some reason that isn't in the ad, I think somebody should say, "Come on guys, if you want to talk about stars give us the whole product line or list."

Phillips: Jack, in your presentations, you are regularly championing indexing obviously, and you tend to have less gracious things to say about active management. When I look at some of the firms out there, I see more of your DNA in a place like T. Rowe Price or American Funds than I do in some of the upstart, very specialized or leveraged index funds. What would your counsel to be to someone? Would you rather buy a lower-cost actively managed fund than a high-cost index fund?

Bogle: Well, I guess the answer to that, since I believe the cost is the single most important factor is absolutely yes, provided they had reasonable diversification and that kind of thing. I think you had a piece of data the other day that said, the average expense ratio in an index fund, if you take all of them and add them up and divide by 200, or whatever the number is, is 129 basis points.

Phillips: And the turnover is over 100%, stunning.

Bogle: Yeah, the turnover over 100%.

Phillips: At some point does it cease to be indexing, if you're not buying and holding the whole market?

Bogle: Yeah, I mean, you can say you index, and you see this all over the place in the exchange-traded fund market, where there are, I think, 1,500 funds, and I think they track something like 1,100 different so-called indexes; some which they make up themselves. So indexing, like any good idea, attracts marginal players; people that think let's jump on the bandwagon; people that think, well, let's have Emerging Cancer, that was one of the early ETFs, and I thought it was not a particularly happy name by the way.

Phillips: It's not what I'm looking for.

Bogle: Maybe  A Cure for Emerging Cancer, and that went the way you would expect it to go, and it's gone. Now we have cloud computing. I don't know what to say about that, to be quite blunt about it. I'm not sure I fully understand what cloud computing is; maybe someone can help me after the session is over. But it's taken a good idea, and it's taken it far too far.

Phillips: Jack, this is our 25th anniversary of the conference. When we hold our 50th anniversary, are you optimistic that this industry at that point will tilt more toward a profession than a business today, or are you worried that it will be the opposite?

Bogle: I'm optimistic that will happen, and I actually expect to be here.

Phillips: It's a standing invitation.

Bogle: In 2001, I wrote a book, it was called John Bogle on Investing: The First 50 Years, leaving hanging that the sequel, John Bogle on Investing: The Second 50 Years, would be out there. As some of you know, I may not walk like I'm 44, or even look like I'm 44. But 17 years ago, I got a 26-year-old heart, so I'm only actually 43.

Phillips: Still young at heart.

Bogle: Yeah, so count on seeing me there. It has to happen, because ultimately--and I have a quote again in this Boston speech from Adam Smith--they call him the first consumer, this is the great Adam Smith, 1776, The Wealth of Nations. They call him the first consumer advocate, and he says, "It's so obvious that I'm not even going to try and prove it," says the great Adam Smith, and that serving the consumer must be the object of every enterprise's existence. It's obvious to all of us. It's obvious to someone selling cars or anything else. But this industry has these two masters, and it doesn't seem to be obvious. The consumer is not always the object of their existence. It's getting bigger. It's gathering assets.

So I can't disagree with you, Don. The industry has gotten somewhat better. But for heaven's sake, as I've often said, success is a journey and not a destination. Some people say that Vanguard is a great firm. Of course, it's not. It should be trying to be great, striving forever to be great. But once you think you're there, not a good idea; forget it, keep working for what your duties are, what you're assigned to do, what your conscience tells you to do. Adam Smith's invisible spectator saying just be the kind of person you want to be when nobody else is looking.

Phillips: Press on regardless.

Bogle: Press on regardless and don't forget to stay the course.

Phillips: Well, you've set a wonderful example in that. Jack, just in concluding, you and I were both at the 50th anniversary of the Investment Company Institute. One of things that occurred to me, with all of the people there that ran big organizations, people that think of themselves as the great leaders of the industry today it occurred to me that when the ICI held its 100th anniversary, everyone in that room will have been forgotten save one person, and that person is you, Jack.

Also, you're probably the only one who was there who will also be attending the 100th. So, Jack, thank you so much for your contributions to the industry and your time here today.

Bogle: Thank you all very much.

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