Eric Balchunas: Assessing Jack Bogle's Monumental Legacy

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Our guest this week is Eric Balchunas, who is a senior exchange-traded fund analyst for Bloomberg Intelligence, where he writes for and leads the fund research team. Balchunas is a fixture in financial media. He hosts the TV show Bloomberg ETF IQ and the podcast Trillions and is also a mainstay of social media under his popular Twitter account @EricBalchunas. Balchunas is also an accomplished author, his latest book being The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions, which we devote this episode to discussing. He earned his bachelor's degree in journalism and environmental economics from Rutgers University.

Background

Twitter: @EricBalchunas

Vanguard: The Early Years

"Inside 'The Bogle Effect'," Trillions podcast, Bloomberg.com, April 27, 2022.

"Investor Jack Bogle Founded His Legendary Company Based on His Princeton Senior Thesis," by Veronika Kero, cnbc.com, Jan. 17, 2019.

"How the Index Fund Was Born," by John C. Bogle, The Wall Street Journal, Sept. 3, 2011.

"Challenge to Judgment," by Paul A. Samuelson, The Journal of Portfolio Management, Fall 1974.

"Q&A With Jack Bogle: "We're in the Middle of a Revolution'," by Michael Regan, Bloomberg.com, Nov. 23, 2016.

"Investing Legend Jack Bogle Says There's a Big Problem With Index Funds," by Sergei Klebnikov, money.com, Nov. 30, 2018.

Bogle's Books

Stay the Course: The Story of Vanguard and the Index Revolution, by John C. Bogle

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns, by John C. Bogle

Enough: True Measures of Money, Business, and Life, by John C. Bogle

Character Counts: The Creation and Building of The Vanguard Group, by John C. Bogle

Other

"Sheryl Garrett: 'The Industry Thought I Was Nuts'," The Long View podcast, Morningstar.com, July 17, 2019.

"Michael Kitces: The Model Has to Change Again," The Long View podcast, Morningstar.com, June 5, 2019.

"Rick Ferri: 'There Are No Average Investors'," The Long View podcast, Morningstar.com, July 3, 2019.

"Gus Sauter: Efficient Markets Are a Good Thing," The Long View podcast, Morningstar.com, Dec. 4, 2019.

"Jack Brennan: Price Pressure in the Advice Business 'Is Inevitable'," The Long View podcast, Morningstar.com, June 23, 2021.

"Jason Zweig: Temperament Is Everything for Most Investors," The Long View podcast, Morningstar.com, June 29, 2021.

Transcript

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Ptak: Our guest this week is Eric Balchunas. Eric is a senior ETF analyst for Bloomberg Intelligence where he writes for and leads the fund research team. Eric is a fixture in financial media where he hosts the TV show Bloomberg ETF IQ and the podcast Trillions and is also a mainstay of social media under his popular Twitter account @EricBalchunas. Eric is also an accomplished author, his latest book being The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions, which we devote this episode to discussing. Eric earned his bachelor's degree in journalism and environmental economics from Rutgers University.

Eric, welcome to The Long View.

Eric Balchunas: Hey, great to be here. Thanks for having me.

Ptak: Oh, it's our pleasure. Thank you so much for joining us. We're really excited to dig in and talk about your new book The Bogle Effect, which is excellent. Maybe a logical place to start is, can you talk about what made you decide to write a book about Jack Bogle?

Balchunas: I had a few reasons. One was I had the opportunity and chance to sit down with him for three separate hour-long interviews in the five years before he passed away. And I had a Dictaphone of those interviews. For those of you under the age of 35 that's what you used to record interviews on. And the Dictaphone was sitting on my desk. And as the pandemic started, it just sort of gnawed at me that I had a chance to hang out with this really great person, legend of the industry. I thought of my kids and that I should probably turn these interviews into something. We thought about doing maybe a podcast series on them. But then, I just felt that I had enough for a book. I wrote my first book on ETFs. And it's like going to a foreign land, and you got to want to live there for two years. And I thought I would like to live there on Planet Bogle, if you will, and I could learn some more, and I could also put a lot of our data into it.

I've always been amazed over the past decade, actually 15 years at this point, covering ETFs, just how much of the flows and the sea change in the industry. If you pull the thread on it, you get back to the mutual ownership structure in 1974. It's amazing how big of a deal that was. And Vanguard alone taking in a billion a day for a decade. We take it for granted. But it's crazy how much money that is. Also, in my research group, Vanguard is not covered by anybody. So, our asset manager analyst covers BlackRock and Goldman and stuff and Franklin, but not Vanguard. And so, I've also wrote it for them, for people in my own group to know how big and unique Vanguard is. I also thought it was a good vehicle to go everywhere. On Twitter, Jeff, we are always debating, and Christine, about all these different things. And so, Vanguard allows you to go to mutual funds, ETFs, advice, trading behavior, you can go overseas. So, it was a great vehicle. And I also thought that a lot of books are written about people who play the game well, rises and falls or just nefariousness. And I get it. That's very interesting. But I thought this is maybe a book that has a happy ending on Wall Street. Let's read about that for a change. And so, those are generally the reasons that I felt like I could do it because I knew it would be painful, and it would be long, and it would take a lot of time. So, all that really kind of pushed me to go through with it.

Benz: So, Jeff referenced that your book is called The Bogle Effect, and you've referenced this in your remarks so far. But what is the Bogle effect, in your opinion?

Balchunas: I used to use the phrase where I think—I still do—the Vanguard effect. When you see Schwab lower their fees and then BlackRock and Fidelity, it's sort of all a byproduct of Vanguard and having to compete with them. So, we used to call that the Vanguard Effect. And as I explored this book, I had a few different titles in mind. But I wanted to put his name first and foremost, because I felt like without this guy himself none of this would have happened. And then, obviously, with the Vanguard ownership structure was very unique. So, those two things I thought were the core catalysts to all the change we see. Index funds merely a byproduct of that initial core. And the effect is just generally the ripple effects across all of the industry. And as I just mentioned before, it's well beyond index funds. Obviously, Vanguard has active funds. The passive funds are actually changing the way other active funds behave. It's getting more concentrated so they can complement Vanguard. Vanguard is getting into wealth management. Wealth management has them getting into private equity. So, you go on and on, and you realize that this is going to be a big deal for a long time. It's not just a passive thing or an index fund thing. And so, I really wanted to put the spotlight on Bogle's character and uniqueness and the structure's uniqueness and build from there and give that the credit for the explosion that is going to continue to ripple out through the whole enchilada.

Ptak: In the book you trace Bogle's life career and long arc. So, I wanted to focus for a moment on the early stages of his life and career. Bogle, he came from what had been a wealthy family, but he didn't lead a life of privilege as a young person. How do you think those early life experiences set him on his future course?

Balchunas: I think they were pivotal. I think a couple of things maybe later were equally as pivotal. But obviously, your childhood is major. First of all, he was always working. He was a scholarship kid. He had a taste or a sniff of the Great Depression. I always tell people, like especially my mom and my family, I would say, "Visiting Jack Bogle was like hanging out with my grandfather, not my father." He was not a boomer. He was a World War II-type guy. He had the same sense of humor. The office had like pictures of warships and stuff, just like my grandfather. And that generation was very thrifty generally. They had just seen things that the rest of us haven't. And I think he had enough of that that was a nice core for him. And obviously, working off of scholarships, he had to work, doing all kinds of jobs, including setting bowling pins. And in my life, as I've met people who had to work through college, they tend to be the most successful people. That's a really good ethic to begin with.

So, I think thriftiness was important. Obviously, that paid dividends later. And in fact, I do think there was some genetics at work though. His great grandfather was a populist fighter of insurance companies. And Bogle lists some of his great grandfather's speeches in one of his books. And it's fascinating how similar their language is. His great grandfather was the one who said, “Gentlemen, cut your costs.” He just copied it. So, there was some genetics at play, I believe, and of course, obviously, the environmental aspects that I said as well. And I think his father was not a great achiever; he didn't achieve a lot and had trouble holding down a job. And I think that also probably sparked Bogle to want to make something of himself.

Benz: The academic thesis that Bogle wrote when he was a Princeton undergraduate was eerily prescient. Can you talk about the main thrust of the argument he made in that thesis?

Balchunas: It really is something how the seeds of Vanguard are in there. Basically, he wrote this thesis that says something along the lines of future growth can be maximized by reducing sales charges and management fees. Funds can make no claim to superiority over the market averages. And the principal role of the investment company should be to serve its shareholders. That's pretty good. That definitely gives some credence to the way Bogle wrote the rest of his life, because circumstance definitely played a big part, but Bogle would put himself as the hero. And some people will push back against that, and there's definitely some truth there. But those core statements are pretty much the foundation of Vanguard.

A lot of things had to happen first, but they're right there. And one interesting tidbit about the Princeton thesis—two of them. One is, he was looking for an idea for the thesis in the library at Princeton. He didn't know what he was going to write about. And he picked up Fortune. And there was an article on mutual funds in that magazine. And it was deep in the magazine, and it wasn't on the cover. You had to be curious to get it. I think his curiosity and reading a lot helped him a lot in his life. In addition, I looked at what was on the cover of other magazines at the same time and Time magazine at the time had Conrad Hilton on the cover. So, I do imagine what if he picked up Time instead? It's interesting how two different paths—he maybe had been a low-cost hotel guy. But the other thing that's interesting is Michael Lewis—I interviewed him for the book—and Michael Lewis has a binder he keeps. And when I told him this, he goes, "Wow. I got to print that out because I have a binder that I keep of Princeton thesis that have changed the world." I'm not sure if he is planning to write a book about it. But the atom bomb was first devised in a Princeton thesis; Teach for America. And there's this history of Princeton thesis having a lot of things that were seeded right there that became actual major accomplishments or events or ideas that formed.

Ptak: That's fascinating. You mentioned serendipity and the role that it played in his choice of thesis. I wanted to talk about another somewhat odd confluence of events. This one took place when Bogle was working for his first employer, which was Wellington Management Company. Can you talk about what happened when Bogle was working there and how that, in essence, brought Vanguard into being?

Balchunas: I'll try to keep this as short as possible because it is a long story literally. And part of the challenge of writing this book was to condense this so I didn't bore the non-nerd people. And I kept rewriting this section, so my mom understood it. Because you can get lost in the weeds here with structures and mutual funds versus the investment advisor. But the long story short is, Bogle in the '60s was given control of Wellington by his boss at a young age. So, he was running Wellington at age 35. And they were having problems, because in the '60s, it was like this past decade where the arcs of the world were crushing it, and boring investors were really having a tough time. And Wellington was more on the boring side. It was conservative. It was a balanced fund. And so, in order to, as Bogle puts it, "I was selling nutritious bagels, but everybody wanted donuts." He figured he'd have to sell donuts.

So, he went over and looked out to partner with an equity manager. And it's interesting. He went through a bunch that said no—Capital Group, Franklin—and I think the fifth or sixth one that he chose was Thorndike, Doran, Paine and Lewis. And they remind me a lot of ARK. They were a high-flying growth manager that was just crushing it. Some of those stocks like Xerox back in the day were like the Teslas of their day. And so, for a while, it worked. It was a good partnership. The flows started coming back in. But then, the bear market hit. And these guys had a real falling out. And I think Bogle felt like he had betrayed his mentor and the company by selling out and giving these other hotshot growth managers too much power in their partnership. They had effective voting control. So, they got into a fight, fingers were pointed, and basically, they fired Bogle.

And so, instead of going off and licking his wounds, like I probably would have done, he basically fought back, and he found a little leverage, which was that he was still the president of the mutual funds themselves. And so, there's this wonky detail that the mutual funds are like shell companies, and the president of those funds actually had some control over—they're like general contractors; they can decide who is doing what role. So, he used that leverage to basically dig in and fight with them. Over the next couple of months, they had a lot of, they called the bifurcation period, and ultimately, the board of the fund said we need a solution. So, Bogle had to come up with a solution that would make everybody happy and somehow pass the board, which had some of his new partners on it, but also some of his older Wellington people who are fans of Bogle, but it had to be unanimous.

Anyway, long story short, what they decided and what Bogle came up with, was the idea to create a back-office company that would just do the boring stuff that Wellington didn't want to do. And they wanted to manage money; OK, fine, you do that. We'll keep you as investment advisor; we'll do all the back-office stuff; I'll run that company. And by the way, we'll make it mutually owned. That way, nobody thinks I'm trying to get out of here and put a bunch of money in my pocket. And so, that's how Vanguard was born as the sort of boring, mutually owned back-office company. And it was just a way to save his job in a way and appease all these different parties so they would be able to resolve this nasty, really unusual situation. I think you're right that that is very serendipitous. And I think it was a great study in just how sometimes the best things come from the worst experiences, and I would say this is a great example of that.

Benz: You referenced Vanguard's mutual ownership structure. Can you briefly explain for those who might be unfamiliar what mutual ownership is and how it applied to Vanguard?

Balchunas: The bottom line is, there's no external owners. The funds own the company, and the investors own the fund. So, ipso facto, the investors own the company. And so, of course, when there's extra profits, the investors who are the owners want lower fees. So, over the years that has just been an upward spiral might be the right term for it. The more assets come in, the more they are able to lower the fees because that's what's in their best interest. This is different than, say, being privately owned or publicly owned where the shareholders may want profits. Therefore, lowering fees doesn't really help with that. In fact, that might be annoying to those shareholders.

I'm not saying that those are necessarily evil or bad structures. Bogle could be pretty savage about that. But he did have a point. He called it the one master theory. You can't serve two masters. We serve one at Vanguard. This structure, by the way, exists in the insurance industry all over the place. It was just very rare for the asset-management industry. And the fact that it really hasn't been copied, I think, speaks a lot to just how—back to the last question—how serendipitous and unusual that other situation was. And if that situation hadn't happened, I don't know if he starts a mutually owned company. But that's ultimately why the mutual ownership structure is so major. It aligns the investors with the shareholders because they're same people.

Ptak: So, while Bogle, he was pressured in so many ways, mutual ownership wasn't necessarily his plan from the start, right? In fact, I think you pointed to a speech in the book he gave in the early 1970s, I think it was to the Investment Company Institute, in which he strongly defended active funds and their higher fees. And that seems like it's evidence that his views really evolved and brought him to this place where mutual ownership and this zeal for cutting costs became his mission.

Balchunas: I have to give Jason Zweig of The Wall Street Journal a lot of credit for this, because he was one of my best interviews. We were talking about this, and he sent me this speech. I hadn't seen it before. But Zweig kept using this phrase "virtue by necessity." And obviously, I put that in there, I put his quote in there. I wanted a lot of voices in there so the reader could decide. Bogle's books are written as him as the hero. And not everybody agreed with exactly how he framed the order of events. But you're right. I think in this case, he was arguing for active management at an ICI meeting in, I think, '71, so this is like two or three years before Vanguard was born. You could tell it's Bogle's voice, because it's feisty and fired up, but it's making the exact opposite argument he made the rest of his life. He was saying that loads are fine, comparing all the active managers to the S&P isn't exactly the right way to do it. And he was really pushing back against some articles that had come out about how active might not be that good. And it was interesting to see it. And I think it really makes the story much more complicated. Of course, that speech is not in any of his books. But it deserves to be put in this one because I'm trying to be as objective as possible.

I do think, though, back to that Princeton thesis, you could tell what Bogle wrote there was clearly in the back of his mind. So, on one hand, I don't think he would have done the mutual ownership structure. He might not have ever even done indexing. But I do think he was the kind of guy that probably was client first. And I think if all that bifurcation hadn't happened, he would probably have been happy running Wellington. He probably would have maybe lowered the fees. I don't know for sure. But I think he would have had a fine life being the CEO of an active mutual fund company had all this not happened. I don't think it would have happened unless the bifurcation nasty experience at Wellington forced him into it.

Ptak: We want to turn shortly to talk about the early humble years of Vanguard. But before we do that, I should turn to Christine to answer this question, because you're quoting her in the book. Her observation, which I think is really astute, was that Vanguard's mutual ownership structure, in essence, it freed Bogle up to experiment in ways that might not have been possible if it was a typical for-profit public or private firm. Can you talk about that a bit?

Balchunas: Christine, do you want to take the first shot at that?

Benz: No. Please go ahead, Eric.

Balchunas: Because it is her quote. But Ted Aronson also said the same thing. He called it a Petri dish. And, it's not that different than anybody getting a business to run. It's not that unique. I think what was different about this was the lack of profit motive. That is something that I think made it unique. But I feel as though having that established and having Bogle as the person running it, it did allow him to do some things and make some decisions that you might not make if you were only concerned about profits. And I think over the years we've seen that. So, I think that's what both Ted and Christine were referring to. But given Christine is right here, I'll let her answer that.

Benz: No, I think that's absolutely right that Bogle and the Vanguard employees were free to go in different directions than the profit-oriented firms were. Eric, I wanted to ask about Vanguard's early days where Bogle used some amusing sleight of hand to convince Vanguard's board that the firm's mandate permitted it to launch an index fund. Can you talk about that and the kind of semantic argument that he made?

Balchunas: This is another total serendipitous situation because, again, had Vanguard run Wellington, I'm not sure he would even be interested in index funds. But because he is running a back office, and he is clearly young, and he does have some ambition, and he is pissed off, he wants to get revenge on his old partners. He reads this Journal of Indexing article written by Paul Samuelson about, hey, somebody should just launch an index fund so we can have something to put up against all these gunslingers. And so, Bogle called it a bolt of lightning, went to the board, and made the case that you don't actually manage an index fund. Therefore, he wouldn't be violating his mandate to not run money, which was one of the mandates when they decided to set up Vanguard, he wasn't allowed to run actual money. So, even the first portfolio manager was called a portfolio administrator.

Later in life, he gave an interview to my colleague Mike Regan, and here's how he said: “Believe it or not, they bought it.” So, I think even Bogle was not sure if they would go for it. But he said that they probably thought, look, “Let's throw a little candy to Bogle,” in his words. And it had Paul Samuelson's backing, which was pretty important at the time. That guy was like a legend. And I think that's why they agreed to it.

Ptak: We're going to come back to Paul Samuelson, which is, in its own way, another moment of serendipity as a part of this story when we talk about the birth of indexing and the role that Bogle played in it. But before we do that…Vanguard is such a juggernaut, now, it's hard to imagine it any other way. But its life as a firm began anything but auspiciously, right? It was very, very humble beginnings. In fact, there was quite a bit of adversity that they had to overcome.

Balchunas: Jeff, you're exactly right. Here's how Bogle described it. He quotes Miss Saigon, as Vanguard being "conceived in hell and born in strife." And if you look at the flows, they had 80 months of straight outflows from the funds that were currently being managed by that back office, which is insane to think about given Vanguard's, the flow machine they are today. So, really, there was no attention. Nobody cared. In fact, they were really struggling. But I will say there's a story in Bogle's last book Stay the Course that I repeated in my book, which I thought was interesting, which was that people in the industry noticed, I think, a little and proof of that was Bogle says he had breakfast with the head of Capital Group, Jon Lovelace in July '74. And he said, Jon Lovelace told him, if you go on with this mutual ownership structure, you will destroy this industry. And I found that interesting in that, A, you could tell anyone inside the industry knew the potential for this, but B, that was said before the index fund was even in Bogle's brain. And I think it gives credence to the idea that it's really the structure because Lovelace obviously was a person who knew what he was doing and was very familiar with the industry. Interestingly though, according to Bogle, he went to Capital Group first to team up. And I have to wonder, if capital group said yes, would they have had a friendlier relationship and not had the bifurcation period. And so, Lovelace could have avoided it altogether. I'm going a little into deep waters there. But it is fun to think about some of these moments and things that could have been. But anyway, to your point, yes, it was pretty much a nonevent when it formed.

Benz: Bogle built Vanguard to avoid what he called the curse of the mutual fund industry. What was he referring to there?

Balchunas: He had, in multiple books, he goes over the other companies that had been the top leader in mutual funds. And the problem they all had is they had active funds where they had a nice run, got all the assets. And then, obviously, they start underperforming, because you can't outperform forever, and then, the money goes away. And he thought that with index funds in particular, they could avoid this curse. Now, they did have active funds as well. But by having predominantly index funds, where they promise you the market and nothing more and nothing less, they could basically avoid that, and I think they so far have.

And this brings up a whole another point of the book, which is that, I do think that the index fund is under-credited in helping behavior, because I do think that when you see these selloffs, if somebody is in an index fund that's 5 basis points, 3 basis points, I think they're resigned to the fact that this is the best deal possible. And then even if the market is not having a good year or month or even decade, what am I going to do? Like, jump ship here and go try to find that the latest hot manager? And I think that resignation is what he was alluding to, is that by promising this and being a good stewardship of that capital as well, you could maintain that leadership position. So, that was what the curse of the mutual fund industry was.

And I interviewed his son, John Bogle Jr., who was an active manager—which is interesting—and he would say that when he would come home, he would say, this is a tough business (about active), because of the fact that you cannot outperform forever. And that's, in my view, what he meant by the curse of the mutual fund industry. And he said, we could avoid that curse, if we just promise the market and be good stewards, but also always see the client as a human being, which brings up a potential Achilles' heel Vanguard has, which is, they're so big—30 million customers—are they still seeing all of those investors as he called it, “honest to God, human beings and souls,” and not becoming a huge bureaucracy? So, he did also allude to something else that wasn't his “curse of the mutual fund industry,” but something that could potentially bring down Vanguard in the future, which is something I think they need to watch out for.

Ptak: But I think we want to pick your brain about that, because that's another theme in the book, Vanguard's size and some of the ambivalence that he clearly felt about it becoming the colossus it's become. Before we go there, though, I wanted to ask you about the directness and focus of Vanguard's model in those earlier days. You could argue that besides mutual ownership, one of his other master strokes was focusing directly on the individual investor. It seems like without that focus Vanguard might not have been able to pursue its mission with the same purity and zeal. Do you agree with that?

Balchunas: Yes, I do. I think that's also why it took a long time. What's interesting about Bogle's journey is this always purposely taking the long road and delaying gratification. And by not paying brokers, it was like he was set up outside the system. But it did attract individuals. He would always bring up Field of Dreams—build it, and they will come. And they did start coming. And I think you're right, having that core, do-it-yourself, heads-up kind of investors as their core served them well.

I would also argue that—and I argue this in the book somewhat—I don't go all the way with it. I interviewed Michael Kitces, and he kind of shot this down. So, I put his view in there, too. Rick Ferri's story in particular helped me think about this—is that just by offering cheap index funds outside of the system, he really helped usher in the IRA era of people leaving the big wire houses and leaving the system. That way they could invest in Vanguard index funds and be more fiduciary. I don't know if you guys have an opinion on that. But that is something that was an interesting point that I didn't go all the way with. I just said, obviously, as Rick Ferri said, I wanted to do what Bogle was saying, but I couldn't where I was. And I have to imagine that was the feeling for a lot of advisors. And now the RIA movement is huge here. And I think that also helped give them stickiness, although all that just took so long.

Benz: You asked Bogle why the assets in Vanguard Index funds were so sticky. It seemed like even bear markets didn't dislodge those assets. He chalked it up to two things: the predictability of index funds and the absence of intermediaries. Can you elaborate on that?

Balchunas: I was kind of surprised because I had come at him with that question from somebody who has seen the RIA movement explode and how many RIAs are champions of Vanguard. They love him and index funds. But as I dove into that answer more and more and really unpeeled it—in some of the other books, he addresses this—what he was really referring to was brokers who churn accounts and are basically trying to find the next active manager and basically, they are too active in the asset allocation in your portfolio. And I think that's what he didn't like. And in Little Book of Common Sense he actually talks about advisors that choose low-cost index funds, and then do planning and this and that, are probably worth it. So, even though he said that then, I think he was speaking in a 1980's mindset when he said it. I think you have to acknowledge the RIA market evolving and he acknowledged that. But that is an interesting point to bring up. His relationship with advisors really is fascinating. And advisors, I think, are big fans of his, but in some ways, they might be making the same mistake that active mutual funds made in the '80s and '90s.

Ptak: Before we talk about Bogle and indexing in depth, I wanted to ask you about a character that you mentioned in the book, this is an actual person, the name of which is Toby Choate. Who was Toby Choate and what was the Toby Choate test?

Balchunas: So, I'd never heard of this. I interviewed Gus Sauter, one of the best interviews of the book. Gus got to Vanguard, and one of the first things he heard is, when they were thinking about spending money, they had a Toby Choate test, which is, why do I want to spend money on and it was basically would Toby Choate, who would be like the quintessential average small investor in the fund, would he be OK with us spending this money? And if we couldn't justify spending Toby Choate's money, because ultimately, it's the investors' money, that they didn't do it. And so, that was Jack's test. And then, Sauter told me later that Toby Choate was an actual real person, whereas Gus Sauter thought it was like a Paul Bunyan fictional person. But it's actually a real person. And I'm telling you, I tried for a whole day to try to get this guy. I don't know, I can't find him—with Google and everything. He's off the grid. But I tried my best to get him so I could interview him for the book, but no luck.

Benz: So, Toby, if you're out there, reach out to Eric. You say Bogle isn't the father of the index fund, but rather the father of low-cost investing. What's the difference in your mind?

Balchunas: I think index funds get way too much credit for the index fund revolution; I really do. If they weren't cheap, they just would not be sweeping the nation the way they are, and eventually, probably the world. But low cost is really everything. And I think two things on that.

First of all, let's say that indexing was never invented from the academics and Wells Fargo hadn't… It just wasn't a thing. I believe with that mutual ownership structure, Bogle would have ultimately wrestled some control of running funds like he did, and he would have launched active funds and probably just made them cheap over the years, because that's exactly what happened with Vanguard's active funds. Their asset-weighted-average fee is around 20 basis points, that's about what an ETF is; Primecap, I think, even the retail share class might be 38; I think Wellington is 24, and then the institutions are obviously lower. Those are pretty low. And the turnover of these funds is also very low. It's like 5%, 10%, something like that. That to me would have been, that's like bringing a gun to a knife fight. And I think Bogle and Vanguard would have made the biggest active fund mutual fund manager six, seven times over had indexing not come along. And again, why? Because low cost. High cost to low cost, is the one thing that threads everything together. And it is indisputable. Because we talk about active to passive, that's a little more gray, because some active isn't that active, and some passive is very active. We talk about mutual fund to ETF. That's a little more gray, because some mutual funds are index funds; some ETFs are highly active. It's very complicated. And I think high cost to low cost, it's the mother of all trends. It's really what I think he set off and encouraged. And so, that's why I think that is big.

I also think it's big, because one of the things I locked into while writing this book was this notion of addition by subtraction. And I feel like that phrase probably sums up his life's work. And I think it's not just low management fees, but it's low turnover. It's removing brokers. It's removing human bias and emotion. He removed a lot of this stuff and took a lot of the friction. So, it's a little more complicated and deeper than just, oh, you buy the S&P 500 index fund, and that's the big trend. I think there's much more going on to what he did. And if you broke it down to two words, I think “low cost” is it. And his son basically said that he has been talking about low costs since the day I was born to quite literally the day he died. So, I think that it might have been his last words. I don't know. But certainly, this was, I think, the mission of his life. And that's why I think that name is better for him than father of the index fund, because he didn't really invent the index fund anyway.

Ptak: I wanted to talk to you about that inspiration for launching Vanguard's first index fund. You referenced it earlier. It didn't come from the emerging school of efficient-markets theory. I think he is often associated with those academics in that school. But instead, it actually came from a famous economist, Paul Samuelson. It was kind of random. Can you tell that story?

Balchunas: So, if you look at the efficient-market hypothesis, I think that gets credited with Bogle and indexing quite a bit. Basically, that all the prices contain all the available information. I just don't think that passes the smell test. Anybody who has watched GameStop or Tesla over the past couple years, there's been multiple cases where you're like, this is not efficient. And I think just sniff-test-wise, I don't think that's going to move people. I get why it's interesting academic theory. But I think Bogle was smart to stay away from that. Because what he did was riff off of it and come up with something called the cost matters hypothesis, which is basically just locking into how much costs can take away from the power of compounding over the years, especially as time goes on. And by focusing on costs and using charts like the growth of $10,000 and showing you if you get 7% versus 5% and just what that does after 20 years, I think that really passes the sniff test much more. I think it was brilliant. And in the book, I talk about the lengths that Bogle went to, to try to explain index fund investing to people because it's not intuitive to an American culture that wants winners. And that was one of those ways. So, we look at multiple ways that he had to sell this concept. And it's interesting. And again, that is also part of why it took so long is because he had to win over hearts and minds. And it's not that easy, especially if people are predetermined to want to pick the best and the winner. And indexing just seems like average and completely a way not to make a lot of money.

Benz: In retrospect, indexing's rise seems like it was almost bound to happen as we've seen advances in data and technology and securities research has become professionalized. And all of those things have made the market more efficient. So, do you think indexing would have risen anyway, even without Bogle?

Balchunas: Yes, I think it would have happened. I think even ETFs would have happened. In the book, I say that they probably have 5% of the assets they have today. That is clearly a number that us analysts can debate. Dave Nadig did not agree with me when I interviewed him. He thought it would be much higher. If you look at other things that have come down, they're usually making money somewhere else. With Schwab and their low commissions, they make half their money on interest income from basically interest on your money that could have been in a money market fund. And I don't blame them for that. That's fine. Robinhood sells your order flow.

Vanguard doesn't do that. And I think over the years, if somebody did try to come in and be like, Mr. Cheap index fund, the way they'd have to make money on the side would ultimately ruin them, and they'd just fall away, and people wouldn't trust low cost anymore. I think with Vanguard, they did it the right way and the long way and the organic way, by having a structure that runs on its own, and there's no gimmicks. The S&P Index 500 Fund that they launched was, I think, 43 basis points. And they had to keep the lights on, obviously, and then it came down. Now, it's 3, but that took 40 years. And so, it was a long, slow, earned cheap. It wasn't a gimmicky cheap.

And in addition, another thing I look at is there are plenty of index funds today that charge a lot more. And even the Wells Fargo Fund, which I think got acquired in December, but the one that was the second one out, I think it was 44 basis points, I believe. And that's not that bad. But that's with Vanguard. So, you can imagine, the industry tends to have incentives that want higher fees, and they know from retail investors in particular, they can make the most money off of them. So, it's just business. And I think there was no natural element to push away from trying to charge as much as possible. Also, if you look at a chart of the asset-weighted average fee of active mutual funds over the last 40 years, it actually goes up until year 2000, and then it starts coming down because that's when indexing got popular. So, there's a couple little things that I find that prove the point that the natural magnet is to get as much fees as possible out of people. Vanguard was just so different. And then when Vanguard started to get popular, that's when everybody started to copy them. And so, that's my thesis.

I also think there's one more interesting tidbit. When the ETF was launched by SPDR and AMEX in 1993, it had an expense ratio of 20 basis points, because that's what the Vanguard 500 Index Fund was at. Let's say the index fund from whoever was 70 or 80, that's probably what it would have been launched at. So, ETFs would be a much smaller thing than they are today had they not started at such a low base and have Vanguard in the picture. So, you just start to look at all these bits of evidence. And I don't know, I just came out thinking indexing would happen, but it would be fringe. I think it'd be for fans of the efficient-market hypothesis. But then, again, 5% of the assets they have today, isn't that bad. It's 60 billion. But I just don't think they have anywhere near 11 trillion, 12 trillion. But it's up for debate.

Ptak: Wanted to switch and talk for a bit about Bogle's talent and his drive, which is legendary. Do you think one of the reasons for Bogle's relentlessness was because he decided to forego so much of the profit and upside by virtue of the mutual ownership structure that they adopted? It seems like it made it more important for him to feel revered for structuring Vanguard as he did and so he ended up taking public stands for things like low-cost investing and Vanguard knowing it would elicit that kind of reaction.

Balchunas: This is a great point. He wrote a book called Enough. And the whole book is about corporate greed and just having enough. There's a little Buddhism in there, I guess. But while he seemed to lack the gene that many people who are driven to Wall Street have of money—they want money, they love money. As Ted Aronson said, it makes us salivate. He just didn't have that. And I don't know if it was because of the random nature of picking up Fortune magazine. And he really probably was better cast in a different industry. Or if it was just because of this circumstance, he felt, oh, now I found a mission that I can lock into. Either way, what I think fueled him wasn't money. It was feeling revered, as you said, and adored. And I think, this sort of sense of mission, and I think it's why he sometimes went from St. Jack to fire-and-brimstone Jack and could annoy people. And one of his former assistants said they had a party and they gifted him with a priest's collar, because he said, if you're going to talk like this, you might as well dress the part.

And I think he could go too far sometimes. I think there were plenty of stories in the book about him overdoing it a little with his speech and really being too savage. A lot of people in this industry are not bad people. And I think sometimes he could paint it that way. But you're right, I think that's what fueled him, and that's what he could never get enough of, ironically. But certainly, being a multibillionaire wasn't a drive for him, which is unusual, I guess. Maybe now, it's more normal, because younger people are less into making all this money.

What was also interesting to me is reading the book Character Counts, which is all his speeches through the '80s and '90s. And as a fan of pop culture, I'm reading these speeches and I'm thinking of what's going on. Like in '87, there's all these people watching Gordon Gekko deliver the "greed is good" speech in the movie Wall Street, and it's inspiring a whole group of young traders to go try to be masters of the universe. And Bogle at the Christmas party in '87 is just talking about how they trimmed 2 basis points, and yada, yada. And the fact that he was so into this one thing when it really didn't matter, was something. So, that sense of purpose was major because it really gave him that focus, that laser beam focus to avoid all these cycles, which can be very seducing.

Benz: In addition to that sense of purpose, it seems like Bogle really thrived on being the underdog, being seen as the underdog. How do you think he would have responded to the challenge of running the colossus that Vanguard has become today?

Balchunas: It's a great question. I went to see him once and he goes, "Ah, we have $3 trillion. Well, it's ridiculous. It's like Oliver Twist: more, more, more." And now they have $8 trillion. So, he clearly found that size to be an issue. Now, people like Elon Musk have taken this, and they've converted into him being against more indexing and low costs. And I'm like that's not right.

What he really wanted was more competition from Vanguard. I think he did think Vanguard tried to do too much, go into too many areas. Obviously, going into ETFs was something he was not into. Had they not gone into ETFs, they probably would have really slowed their growth, and maybe that would have been Jack's happy place, like $2 trillion with just index mutual funds or something like that. But they did go into ETFs and are growing quickly. But what he wanted was more competition. He even said he hoped that Vanguard's market share erodes someday, which is weird, and again, talks to the different trip he was on because that would mean other people got cheaper. But I don't think his worry about Vanguard being big was because he thought people should go active more. It was more about this thing we talked about—we've met the enemy and it's us. We're now a big bureaucracy that doesn't care about the people. And this is a guy who saved all the letters he got from investors. So, the idea of being this big was just not in his mind.

That said, you also had to untangle the hurt feelings he had from getting sort of ousted from the board and his issues with Jack Brennan and them going into ETFs a couple years after he had said no, and maybe he just was pouncing on Vanguard a little extra hard because of those feelings. I had difficulty untangling those hurt feelings with Bogle just being honest Bogle. It was difficult, but I did my best. But I do think he would have been increasingly uncomfortable with Vanguard's size, right or wrong.

On the flip side, Vanguard going into these places like ETFs and potentially even private equity, you could argue maybe those things needed a little Vanguard-ing. Is that so bad? So, I tried to balance this conversation in the book because I think the Bogleheads, they react a lot to Vanguard's moves. But at the end of the day, a lot of Vanguard's flows and assets are still in very Bogle-ian stuff. And I think it's going to be an ongoing issue. But I think the divide is a lot closer than people think. I don't think the gap is that wide. But Bogle certainly was very vocal about this.

Ptak: I wanted to turn and talk about the future of Vanguard and indexing building on a 2017 speech that Bogle gave, which you reference in the book. In it, he called indexing's growth rate frightening. What did he mean by that? And is it a warning we should be mindful of as passive continues to take market share?

Balchunas: Again, it's my opinion that Bogle would never say, "Hey, listen, you, who are about to go into a 3-basis-point index fund, don't do it. Go buy this 80-basis-point active blend fund, instead." I just don't think he would ever, ever say that. He just couldn't. It'd be like against his whole like heart and DNA. What he didn't like was the concentration of power in the passive giants. If anything, active mutual funds are much more dispersed in their assets. But in passive, it's really two companies that control almost all the assets—BlackRock and Vanguard—and he worried about them having too much power and too much voting control. And I think that's an issue that is totally important and relevant. It's coming up again and again. Vanguard itself doesn't own those shares; it's 30 million investors. So, how do you channel all those people into the vote? Or do you come out with a new rule that says, instead of a fund only allowing to own 10% of a company, maybe we have a whole fund complex having the 10% rule, because as of now, Vanguard could keep growing.

I will say, though, there is a limit. As you guys know, I think mutual funds and ETFs only own somewhere around 40% of the stock market. So, even if Vanguard was 100% of the mutual fund business—not that they'll ever get there. I think they're over a quarter now, though. That would still mean 40%. But I interviewed Buffett about this, actually, and he said, this will probably be a regulatory issue down the road, but that's an issue for another day. And I agree with that. I think at some point the regulators are going to step in, and maybe they just have a new rule on how much an actual complex can own of a stock. Because, really, that is a lot of power in a few hands. And I think that's ultimately what he was worried about there. I think that's also sometimes a way for him to be a little savage to his competitors, because he was on ETF IQ, and he brought this up, and he said, “Come on in, the water is warm. Where are all the competitors? We are waiting for you.” And he could be a little ruthless like that. So, sometimes he'd make these claims almost as a way to remind everybody how great his work was and how great Vanguard was. That's my opinion. And I also think sometimes the things he said, you could find something else that might contradict it a little bit. Not all of it lines up perfectly. But I guess that'd be my answer for that. I don't want to belabor it.

Benz: Bogle probably had mixed feelings about financial advisors embracing low-cost investing. It meant that his message had gotten through, but they were often charging clients 1% of their assets and siphoning off some of the cost savings achieved by adopting indexing. What's your take on that?

Balchunas: This is the next big issue, and I go into this in the book. And you have to wonder. Advisors, champions of Vanguard, and one thing I looked at in the book is this concept of dollar fees. And Christine, you had some great language around this that I included, which is a percentage can look very innocent because you're not writing a check. But when you convert that to dollar fees for yourself or for the company as a whole, they get enormous. And what Vanguard did was share those economies of scale. What active mutual funds did not do in the '80s and '90s was share it. And I think there was a missed opportunity to bank goodwill and increase their beat rates. And I think that also is why Vanguard was so disruptable.

Are advisors making the same mistake? And I know, sometimes they have sliding scales, perhaps it will all work out. But if you look at what you're paying as a percentage versus a dollar fee, the dollar fee is usually way more than you think. But that said, people still are OK with it rather than having to write a check. It's a complicated psychological situation. But I do think there's a whole movement with the hourly advisors and flat fee. And I know this is an issue that Rick Ferri is dropping bombs on Twitter on all the time. Advisors tend to control the conversation a lot, because everybody is trying to sell stuff to them.

So, the fact that Rick is out there doing this is, probably useful to get this debate going. But you wonder, are they making the same mistake? Should they think about sharing economies of scale? And it's something I posed in the book. I asked Bogle about this. And he said that the fee-based structure would actually go away. And they would move to a more “professional model,” which was hourly or “as visit.” And I think that's where the Sheryl Garretts and the Rick Ferris of the world are going, although I interviewed Michael Kitces about this, and he said, “Nah, that's going to remain fringe, it's going to stay here.” That said, Kitces said that Vanguard and Schwab, which now has low-fee advisory services on their own … Vanguard has 1,000 CFPs now, and that's a lot, and they charge 30 or below. There's a big middle that's probably going to get disrupted. But people who specialize or do very high-touch work are probably fine.

But I would argue that the asset-management industry, and then the advisory industry could ultimately start looking more like the airlines in 20 years, where you've got a couple of giant providers or issuers, and then you've got 20% doing unique, fringe, specialized work. And it's possible the advisory world moves to that model ultimately as well. But that's sort of what I touch on a little bit, although I don't go as far to say all this is going to happen. But this is potentially the kind of thing that could happen. We've seen consolidation happen in many other industries. But I think the advisor world is probably the next area to watch. And obviously, Tim Buckley has pointed right at them and said, “We're coming for you,” which is interesting because a lot of Vanguard's biggest fans are advisors. So, it could get a little interesting down the road given that you're now a customer of somebody who is coming to compete with you.

Ptak: We have a couple of last questions for you. Before I did that, I would just quickly interject that it occurs to me as you mentioned their names, Sheryl Garrett, Michael Kitces, Rick Ferri, Gus Sauter, Jack Brennan, they're all folks that we've happened to interview on this podcast. So, if our listeners are interested, you want to learn more about those folks and their views, go back through our library. Onto my question, some firms take a longer-term view, and they'll hold the line on things like rolling out new products, but most don't. It seemed easy to chalk that up to incentives and inertia back when the big active shops were dominant, and Vanguard was the upstart. But now that Vanguard is dominant, why don't we see more firms trying to adopt at least some of the practices that Bogle and Vanguard ushered in?

Balchunas: Well, that's a great question. And one of my reasons for writing the book is, I've just had the question, how come nobody copied their ownership structure? And of course, everybody had the same answer: There's no economic incentive. And that would probably my answer to you here. That said, now that all the people are clearly voting with their feet and all the money goes to low cost—virtually, all of it, not all of it—I think a lot of other companies are copying Vanguard's low-cost index funds. And honestly, I think a lot of them are happy to. If you meet a BlackRock ETF person, they feel good about offering some low-cost beta. I think, Bogle, while he was savage, I think he helped increase people's feeling good about serving their clients and the industry, even if it took a little kicking and screaming or just copying, being forced to. So, I give them credit for that.

But that's what's so interesting. Nobody has copied their ownership structure, but the industry is kind of governed by it at this point. You have to have something going on here. Unless you're really, really good at something else. There's a few people who are just outside of the Vanguard effect, and we study them because it's interesting. It's like being immune to something. But most people have to have a solution for this, which is another reason I wrote the book. I wanted to speak to our clients, too, and be like, you should have a plan for this. This company is a major deal. Even if you aren't going to copy them, you're going to have to have some kind of plan for this big movement.

So, I think that we're going to continue to see companies get more Vanguard-ish in the products they launch. But here's the thing. I interviewed Bogle in the last interview, which was six months before he passed away, and he was in a very prophetic mood. And he said, “I'm telling you right now, this whole industry is going to have a mass mutualization.” And he claims that some of these big estimators are going to be so desperate after a bear market that they're going to mutualize themselves, which I could find nobody to agree with this. There were three things I asked everybody, and even his closest, people who really loved him. Rick Ferri, Burt Malkiel, nobody agrees with him on pretty much three things: international, ETFs, and that the whole industry will mass mutualize. So, I'll leave it there. But that's what he says is going to happen. He thinks there's just going to be companies converting to the structure.

To answer your question, I think consolidation is more like it. And then, just having a line of low-cost Vanguard-competing products is probably the way to go. The BlackRock model probably is the one a lot of big companies are going to take where you're just so diversified and crafty and hustle. BlackRock hustles, and they're able to stay alive, and that subsidizes their competition with Vanguard. So, I think the name of the game in the future for the big guys is how can I subsidize competing with Vanguard in the beta areas? And I think that's what we're going to see play up.

Benz: For our last question we wanted to ask about Bogle's books. It seems like you must have read every Bogle book in researching and writing your own book. You've referenced several of his books. Bogle was a gifted writer and communicator, wonderful speaker. What's your favorite of his books and why?

Balchunas: I did read them all. I feel like I got my CFA Level II Bogle or something. There's a lot of good stuff in there. I certainly learned a lot and felt like I was hanging out with him. I will say, for somebody who has hung out with him, reading his books are a lot like spending time with him, which is good. That's a sign of a good writer, because there he's putting his personality. Little Book of Common Sense, to answer your question, is easily his best book. I referred to this as his Sgt. Pepper's. This is where it all came together. He puts his personality in there a little bit. But really, if you were to give somebody who just wants to learn how to invest, the book, this should be right up there. I would also couple this with Stay the Course, his most biographical book and his last book, and it tells the story of Vanguard very well. I think those two books are a good one-two punch, and you get the full Bogle effect in those two, I think, more than the others. And then, I think as you go back in time to his first book, his personality comes out more and more in each, and I like that. I like to hear his voice in the books. And so, I like the ones that he wrote a little later better, but that was just me.

Ptak: Well, Eric, this has been such a fun conversation. Congratulations again on writing a great book. And thanks again for being our guest. We very much enjoyed having you on.

Balchunas: Oh, it was a pleasure. I'm a big fan of you guys, of Morningstar, which has tons of mentions in the book, by the way, and I got a couple of charts and stuff. And so, it's a real honor. Thank you very much for asking me.

Benz: Thank you so much, Eric.

Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: And @Christine_Benz.

Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)