McNabb: Always Apply the Five-Minute Rule

Dan Culloton: I'm told that in your speech, you're going to talk about something called the five-minute rule, if I have got that correct. What is the five-minute rule?

Bill McNabb: Yeah. So, broadly I'm going to talk about three building blocks of trust and one of them is simplicity. And five-minute rule is something which I shamelessly borrowed from a report written by Ennis, Knupp, one of your great Chicago institutional consultants. And it's essentially if you don't understand an investment idea in five minutes, take a pass; whether you are the most sophisticated institutional investor or a retail investor trying to figure out how to save for college or retirement.

And I will tell you, we actually use essentially the analogous rule inside Vanguard in some of our most sophisticated groups, whether it's our quantitative group or our fixed income group when they are looking at new vehicles. If it doesn't make sense, you take a pass, and it's helped us avoid a lot of landmines as you can imagine.

It sounds overly simplistic, but I actually think there is a corollary as well, and that's we as providers of investments and investment services if we can explain something to someone in five minutes and why it makes sense for their portfolio, they should take a pass as well.

Culloton: Do all of Vanguard's funds and offerings currently meet the five-minute rule?

McNabb: I think most do. We're actually going to go through a process where we will actually put everything to the test. We have a couple things, I would say, in experimentation, which certainly don't and that may doom them for introduction. I think it's actually a really great concept. If you think about it, it's easy to be a Monday morning quarterback right on SIVs, and some of the things that went on in fixed income and money market funds because of SIVs.

But when our teams peel those things apart, our legal team and our fixed income team, we could not understand why they were rated the way they were; it just didn't make sense. And you could say, "Well they are rated that because it's really somebody who could see something that we don't see." But we couldn't understand it, and we couldn't understand it pretty easily, so we took a pass, and again it ends up being one of the better decisions we've made in the last few years.

Culloton: Last few years Vanguard has been a leader in fund flows through up markets and down markets. It's currently the largest mutual fund company in the world by the way we measure it. We've seen this before. We've seen that nobody stays on the top of the mountain for very long. What worries you? Do you worry about falling off the pinnacle? Do you worry about competitive threats? Do you worry about something that Vanguard can do to breach investors' trust, and how you're guarding against that?

McNabb: Well, I think trust is the most important thing in our business, and it actually is the cornerstone of what I'm going to talk about at lunch today with a broad group, and it's the thing I go to bed worrying about every night. And for us it's a little easier, because the ownership structure removes a lot of potential conflict there, and I think if you walk around the campus and you talk to the 12,000 people who work at Vanguard, they are all focused on a singular mission, and it's to help investors get to their goals.

We really do want to make the world better place for investors. The size stuff is interesting. I couldn't tell you if we're number one or number two or number three. I can tell you about the flows, because obviously we see that every day, but it's not a goal; it's an outcome.

And our goal is just to keep executing on the mission that's been in place for 35 years. We celebrated our 35th anniversary of operations on May 1, and it's really fun to look back on sort of what's changed and what hasn't changed, and the bedrock principles are still very much intact, which is to really deliver on this promise to the investor.

That's the thing I worry about the most is just making sure that every day all 12,000 plus of us come to work with that sole focus, and we just could never lose that.