Bogleheads® Conference 2014 -John Bogle & Bill Bernstein Fireside Chat

00:00:00.000 | [BLANK_AUDIO]

00:00:07.400 | >> Okay, a number of years ago, Jack Ice and Bill Bernstein could

00:00:12.560 | have an informal chat as part of the agenda.

00:00:15.680 | We all know what Jack wants, Jack gets.

00:00:19.840 | So it's become a regular part of our conference agenda ever since, and

00:00:23.800 | it's now affectionately known as the Barside Chat.

00:00:27.840 | So without further ado, I'd like to briefly introduce the two participants of

00:00:31.560 | this non-political discussion.

00:00:33.620 | >> [LAUGH] >> I have to say that every year.

00:00:37.720 | >> [LAUGH] >> Okay, our distinguished guest of honor

00:00:41.560 | is the founder of the Vanguard Group and

00:00:43.280 | president of Vanguard's Global Financial Markets Research Center.

00:00:46.760 | He created Vanguard in 1974 and served as chairman and

00:00:52.120 | chief executive officer until 1996, and as senior chairman until 2000.

00:00:58.920 | He entered the investment field immediately following his graduation from

00:01:02.080 | Princeton University, magna cum laude, with a degree in economics in 1951.

00:01:07.160 | If I listed all of his honors and achievements,

00:01:10.640 | which most of you already know, we wouldn't have any time left for the Barside Chat.

00:01:16.240 | So I'll dispense with that, and I ask you to please welcome our special guest of

00:01:19.480 | honor, Mr. Jack Vogel.

00:01:20.960 | >> [APPLAUSE]

00:01:30.960 | >> Jack's companion for

00:01:32.200 | this Barside Chat is a retired neurologist who helped co-found Efficient Frontier

00:01:36.640 | Advisors.

00:01:38.000 | He's written a number of best-selling titles on both finance and

00:01:41.280 | economic history.

00:01:43.040 | He holds both a PhD in chemistry and an MD.

00:01:46.360 | Please welcome one of the smartest guys I know, Dr. Bill Bernstein.

00:01:49.600 | >> [APPLAUSE]

00:01:56.480 | >> It's all yours.

00:01:58.080 | >> Okay, well, I have been sternly warned that any speakers who mumble will be

00:02:03.440 | promptly cut off, so please, before that happens, start shouting, stop mumbling.

00:02:11.800 | >> [LAUGH]

00:02:13.280 | >> I'm going to lead off, Jack,

00:02:15.760 | with a question that is kind of a counterfactual.

00:02:21.600 | Let's assume that it's 20 or so years ago, and

00:02:27.160 | the success of your concept of a popularly available retail fund has succeeded.

00:02:35.760 | You've got the Index Trust 500 fund, the total stock market,

00:02:39.720 | you're starting to dabble in international markets, and maybe even some slice and

00:02:43.760 | dice in the US market, and that's working out pretty well.

00:02:47.400 | And let's start from that point forward.

00:02:50.960 | What would you have done differently from that point forward?

00:02:58.760 | >> Are you allowed to think before you answer a question in this day in America

00:03:01.680 | or not?

00:03:02.200 | >> You have as long as you need.

00:03:05.800 | >> Okay, but I guess if I had to do it over again, what would I do differently?

00:03:09.800 | Well, you only went back 20 years, and

00:03:15.160 | Vanguard was pretty much formulated almost immediately, 40 years ago as it happened.

00:03:20.600 | And so 20 years ago, I guess if I had done, would do anything differently,

00:03:25.560 | I would probably have a little less impact on marketing, be less of a marketing person.

00:03:31.040 | Some of the funds I started, Vanguard Quantitative Portfolios it's called,

00:03:37.520 | later named, Vanguard Growth and Income, Vanguard Asset Allocation,

00:03:42.680 | which Bert Malfield used to say, it'll never work.

00:03:49.600 | And it worked for 20 years, and then it stopped working.

00:03:53.160 | And I should have known, man, I should have had a 25-year time horizon.

00:03:57.600 | And so starting some funds that really, probably I shouldn't have started.

00:04:02.840 | And we continue to do a little bit of that, I'm not too, these aren't my problems.

00:04:06.480 | Because I could do it any differently if I wanted to.

00:04:09.240 | Things like the managed payout portfolio.

00:04:17.160 | I think anything that thinks it can improve much on indexing is fundamentally,

00:04:21.640 | that's the burden that every fund has to have.

00:04:23.800 | Will it do better than the market index?

00:04:25.600 | I just don't see how you can say that.

00:04:27.640 | On the other hand, we all have, even Bogle,

00:04:31.200 | after all these years of learning better, of knowing better,

00:04:36.120 | still has too much of a marketing hat on.

00:04:38.960 | It's not that we need the money.

00:04:41.160 | My God, $3 trillion?

00:04:43.520 | What does that mean to somebody who's written a book called Enough?

00:04:45.880 | >> [LAUGH]

00:04:50.160 | >> So, I'm more worried about that.

00:04:52.480 | But you end up kind of thinking, or I did,

00:04:55.460 | it was a good idea to kind of preempt other people from coming into the field.

00:04:59.760 | So we didn't want to allow people to have something that would properly be a Vanguard

00:05:04.320 | show at higher prices.

00:05:09.960 | So we basically said, we're gonna start this fund or that fund,

00:05:12.200 | index funds of various types.

00:05:15.080 | And basically say, stay out of here, you're not gonna be able to compete with us.

00:05:20.080 | I think we maybe could push that too far, and I think maybe I pushed it too far.

00:05:24.160 | But in terms of deep progress, in terms of policy, strategy,

00:05:28.280 | structures, which I'll talk a little bit about later.

00:05:31.840 | I just plain don't have any deep regrets.

00:05:36.200 | Little regrets or something else again.

00:05:39.360 | I've made so many mistakes that in my life, that I tell people.

00:05:44.760 | My wife has forbidden me to write any more books.

00:05:47.240 | And I said, if I were to write another book,

00:05:49.080 | it would be the longest book I've ever written.

00:05:51.280 | And it would be called Mistakes I Have Made.

00:05:53.080 | >> [LAUGH]

00:05:53.920 | >> And that would go way back in my early

00:05:55.800 | career, when I was just so stupid, it defies description.

00:05:59.880 | But the big advantage I have, I think, is I was willing to learn from my stupidity.

00:06:05.480 | And we all should be able to do that.

00:06:07.840 | Learning from your own mistakes is much deeper and more profound.

00:06:13.000 | We're learning from other people's mistakes, because somehow the lesson

00:06:16.400 | isn't quite as sharply drawn as to when you just kind of

00:06:21.120 | shoot yourself in the foot or in the brain or some other place.

00:06:24.640 | It can be equally painful.

00:06:26.160 | So I don't, no deep regrets.

00:06:30.120 | >> Well, that segues into another question,

00:06:32.560 | which is, should Van Gogh be advertising?

00:06:35.880 | >> Well, that was my marketing hack.

00:06:42.680 | And I didn't know how else, cuz we had no sales force.

00:06:47.440 | And how else to get the information out of the Van Gogh fund.

00:06:51.560 | So we had kind of an introductory fund that was likely to hack the page.

00:06:54.600 | It was sort of eternal.

00:06:56.280 | And we had a new fund, we kind of told the world that we were going to do it.

00:07:00.760 | Absolutely laid down the rule, which we have continued to observe.

00:07:03.920 | No performance advertising, no yield advertising.

00:07:08.240 | I'm a little too far back.

00:07:09.800 | I didn't obey that warning.

00:07:11.320 | Now I can hear the echo, that's good.

00:07:13.480 | >> [LAUGH] >> So sorry about that.

00:07:15.560 | You missed nothing.

00:07:16.400 | >> [LAUGH] >> But

00:07:21.000 | it was supposed to be very modest.

00:07:24.240 | It was.

00:07:25.440 | And I have to concede that I wasn't too spittin' with spending

00:07:31.760 | $50 million of our shareholders' money on Vanguarding, our sort of campaign slogan.

00:07:38.200 | I don't think we need that.

00:07:39.840 | But I have conceded that you have to have a name like that with gang at the end.

00:07:45.640 | It's a good thing we weren't Merrill Lynch.

00:07:47.360 | >> [LAUGH] >> And

00:07:54.560 | I wish I had a little bit of advertising.

00:07:57.200 | Because then when you start advertising, it would be very observable.

00:08:00.960 | But I did a little, and I don't think we really do a lot now.

00:08:04.880 | I don't know what the cost of the Internet is.

00:08:06.560 | I'm just not familiar with that.

00:08:08.960 | But we do quite a bit along those lines.

00:08:12.800 | And it's okay.

00:08:14.360 | It's not gonna, the cost involved in terms of unit costs are really quite trivial.

00:08:20.920 | I don't change our expense ratio.

00:08:22.560 | And I own it.

00:08:24.080 | But I'm more into the principle of saying, as I did at the very beginning,

00:08:29.880 | as Ralph Waldo Emerson, build a better mousetrap and

00:08:33.720 | let the world be a path, and the world will be a path to your door.

00:08:37.680 | And that was how we began a long time, we'll talk about later.

00:08:41.200 | And so I think advertising is not a good thing.

00:08:48.680 | But very limited in the way we do it, it's okay.

00:08:51.880 | A lot of people are out there, particularly in the go-go years.

00:08:54.840 | Not the go-go years, but in the late 90s with all the tech funds and so on.

00:09:01.560 | They're advertising their returns.

00:09:03.560 | How would you like 40% a year?

00:09:05.760 | I, for one, would like 40% a year.

00:09:07.960 | I just don't know how to get it.

00:09:10.160 | And so, it's not as bad as marketing.

00:09:17.200 | Advertising is not as bad as marketing.

00:09:18.840 | Because marketing, when you think about it, what is marketing?

00:09:22.720 | Marketing is finding out what clients want and giving it to them.

00:09:28.080 | And that's the way beer works.

00:09:31.280 | That's why we have light beer, I guess.

00:09:33.440 | I don't do light, I do ale, just for the record.

00:09:37.120 | And rarely, sometimes in the summer.

00:09:40.360 | But you're always trying to find out that these big consumer products companies do this,

00:09:46.840 | or are doing this all the time,

00:09:48.760 | and trying to add a little bit of something to something else,

00:09:51.520 | and sell a little bit more.

00:09:52.880 | Because that's what they think the public wants.

00:09:55.040 | And it's a good idea for cereal,

00:09:57.880 | probably a good idea for automobiles, and beer, and God knows what else.

00:10:03.280 | But I think a terrible idea for investing.

00:10:06.640 | And the great public out there usually wants the wrong thing.

00:10:10.200 | What they read in the paper in the last two or three weeks.

00:10:12.560 | Imagine how many gold funds there would be around,

00:10:15.360 | after gold had that huge run,

00:10:17.760 | I guess about two and a half years ago.

00:10:20.240 | Maybe three years ago, two years ago.

00:10:23.640 | So, I know it sounds old-fashioned,

00:10:28.640 | but I'd let your term speak for itself,

00:10:33.120 | record speak for itself.

00:10:35.840 | People start to trust you,

00:10:37.560 | as many, many people trust Vanguard,

00:10:39.960 | and have that the way you basically build business.

00:10:44.960 | I don't think we need to worry about that again for a long time.

00:10:48.360 | And we have happily a formula that really always can't go wrong.

00:10:53.680 | And I tell people, we haven't promised you a fund that beat the market 15 years in a row.

00:10:59.840 | We haven't promised you a Magellan fund that gets to a hundred,

00:11:04.440 | gets to a billion dollars and is now about 20 million.

00:11:07.600 | We had a good performance and then a bad, money flows in and out.

00:11:10.720 | We're right down the middle.

00:11:12.080 | And as I constantly advise people,

00:11:13.880 | and I advise all of you,

00:11:15.560 | we make no guarantee except we will give you your fair share of the return of any portion of the market,

00:11:23.280 | particularly stock and bond market that you would like to invest your money in.

00:11:27.920 | And that fair share means if the market goes to hell in a handbasket,

00:11:32.280 | your investments will go to hell in a handbasket.

00:11:35.080 | And we should say that.

00:11:37.240 | Maybe you shouldn't use a word like hell.

00:11:40.440 | Maybe you should too, I don't know.

00:11:43.120 | Going to heck in a handbasket doesn't cut it.

00:11:45.800 | So, that's it.

00:11:49.320 | Thank you. I mean it sort of reminds me of the famous Henry Ford aphorism,

00:11:55.320 | that if you ask the public what it wants, it will tell you it wants a faster course.

00:12:00.080 | The Shiller P/E, the CAPE, Cyclically Adjusted P/E Ratio has gotten a lot of attention.

00:12:12.800 | It's become a real topic of conversation, which is worrisome in itself.

00:12:17.680 | You know, it's still around, what, 25 or so.

00:12:20.880 | You know, what do you think of Shiller's measure?

00:12:25.840 | Do you think it can be improved upon?

00:12:27.240 | Should we not be paying so much attention to it?

00:12:30.040 | Well, anyone that has a formula to tell you whether the market is high or low,

00:12:35.840 | is kidding, either trying to kid you or has been kidding themselves.

00:12:42.640 | And nobody knows this.

00:12:44.360 | Take the Shiller P/E, last 10 years ago, it was right where it is now.

00:12:51.440 | I think it's around 25 or 26, and it hadn't changed.

00:12:55.400 | So, it's giving a warning now that the market is too high.

00:12:58.800 | It was giving a warning then that the market was too high.

00:13:02.760 | And since then, the market has gone up 60 percent.

00:13:05.200 | Earnings and dividends have gone up, well,

00:13:07.120 | earnings have gone up, I think, 70 percent.

00:13:09.000 | Dividends have gone up 100 percent.

00:13:10.880 | So, it was a false signal 10 years ago.

00:13:14.280 | Some look at it and enjoy it.

00:13:15.760 | I do, and I often use it when I go on CNBC.

00:13:19.840 | And it's trying to deflate everybody's expectations.

00:13:23.040 | But there is no answer.

00:13:24.880 | Shiller is fun to look at, it's intelligent.

00:13:27.600 | Don't just look at the last year's earnings and the next year's earnings.

00:13:30.520 | We'll do a little bit of history,

00:13:31.920 | but it doesn't tell you very much of anything.

00:13:34.640 | We can get right down to the greatest hazard.

00:13:37.040 | Yeah, I would certainly agree with that.

00:13:41.160 | You know, if you, people are always fond of saying, well, gosh,

00:13:44.200 | the historical average is 16 and a half or whatever it is.

00:13:48.360 | But, you know, to get that number,

00:13:50.080 | you've got to include data that goes all the way back almost to the Civil War,

00:13:53.480 | which was a different era when industrial stocks were selling four times.

00:13:57.720 | I mean, that, that's, that's gone.

00:13:59.840 | And if you look at it over the last 50 years,

00:14:02.080 | you use it to draw a regression slope where the normal value appears to be closer to 20.

00:14:06.760 | So I think the value of 26 really doesn't tell you all that much.

00:14:13.800 | Well, let's, let's ask the shift gears a little bit and get into some personalities.

00:14:17.760 | Let's, let's go to the sunglass question.

00:14:20.440 | Which is that, you know,

00:14:23.760 | there have been star managers for forever,

00:14:25.920 | starting with what, Ivor Kruger and then Jeremy Tsai and, you know,

00:14:30.880 | Peter Lynch and Bill Miller and now another guy.

00:14:37.160 | And I'm wondering, do you think the public has,

00:14:39.520 | has learned anything or do you think that the birth rate is higher than the learning curve?

00:14:44.720 | Well, the problem with this business is it has a kind of

00:14:51.920 | distribution arm that has to sell something.

00:14:56.640 | And if you want to talk about,

00:14:58.880 | you've got a client out there and you want to sell them a certain thing,

00:15:02.440 | it has to have a good performance.

00:15:04.160 | And there's nothing else for you to show up and say,

00:15:07.000 | well, our expense ratio is only 10 basis points instead of 100.

00:15:11.480 | I think your client is thinking,

00:15:13.560 | "Duh, what does that matter?"

00:15:16.360 | Particularly since the 100 doesn't even cover what the fund spends,

00:15:19.480 | like transaction costs, marketing costs, and things of that nature.

00:15:23.280 | So, it's an action business.

00:15:28.280 | Investment advisors basically feel the need to tell you to do something.

00:15:33.400 | Portfolio managers, and I keep thinking of it,

00:15:37.040 | and this is an interesting point.

00:15:38.840 | I keep thinking of Peter Lynch,

00:15:40.720 | manager of the Magellan Fund,

00:15:42.280 | going to see Ned Johnson on January 2nd of a given year.

00:15:46.880 | And he says, "Ned, or Mr. Johnson,

00:15:50.840 | I looked at my portfolio and I think it's fine for the year,

00:15:55.560 | and I'll see you a year from now.

00:15:57.240 | I'm not going to do anything in one year."

00:15:58.720 | The odds are 51 percent that that will improve the fund's performance during the year.

00:16:02.880 | It's improved. And all that transaction, it costs money.

00:16:06.720 | And sometimes it adds value,

00:16:10.200 | but more often than not, it's value.

00:16:12.600 | Well, it's returns. But the portfolio manager,

00:16:15.640 | and people are saying, "What are you doing?

00:16:17.200 | You've got to be doing something."

00:16:18.800 | And turn off all those,

00:16:21.600 | I won't get into the scandal we have about our Pennsylvania judges,

00:16:24.760 | and yet, their pornographic emails.

00:16:27.360 | But that's another story.

00:16:29.840 | But you feel the need to do something.

00:16:33.880 | Trustees of an endowment fund feel the need to do something.

00:16:37.440 | Investment advisors feel the need to do something.

00:16:40.000 | Financial advisors or RIAs feel the need to do something.

00:16:43.600 | And I'll give you one little anecdote.

00:16:47.320 | I was speaking out in Milwaukee a few years ago,

00:16:49.920 | and I went through my little platform of bonds and stocks to keep the ratio right,

00:16:54.200 | and don't do anything else.

00:16:55.840 | So, one of the financial RIAs in the room comes up to me afterwards and said,

00:17:00.320 | "Look, I know your advice is right,

00:17:03.360 | but think of me a minute.

00:17:04.720 | Think of me." He said,

00:17:07.280 | "I've got a client." And he comes in and set up his portfolio in 65 percent stocks,

00:17:11.440 | 35 percent bonds, and he comes back a year later.

00:17:14.640 | He says, "What do I do now?" He said, "Nothing. Nothing."

00:17:17.480 | He said, "I guess that's okay to go a whole year without doing anything."

00:17:20.360 | Comes back a year later, says,

00:17:22.440 | "I must be doing something now, I didn't do anything last year.

00:17:24.280 | How about this year?" "Don't do anything."

00:17:27.080 | Comes back a year later, this is now the third year,

00:17:30.440 | "I got to do something now, this is just crazy."

00:17:33.200 | And the advisor says, "No,

00:17:35.680 | stay the course, stay exactly where you are."

00:17:38.800 | And he said, "The client then says to me,

00:17:42.440 | 'What do I need you for?' How do I answer that question?"

00:17:47.200 | And I said, "The answer is easy.

00:17:49.440 | Just tell him you need me to keep you from doing anything."

00:17:52.840 | And there really is, and we make fun of it.

00:17:58.000 | But there's a lot of truth in that.

00:18:00.680 | This is a business where activity is big.

00:18:04.160 | Never have admired it as it is today.

00:18:06.120 | I mentioned the spider thing turning over at that awful rate,

00:18:09.480 | and it traded,

00:18:12.040 | I guess I mentioned this to Christine Vance earlier.

00:18:14.520 | The spider traded $160 billion in the last five days,

00:18:20.520 | and the assets of the spider are $160 billion.

00:18:24.120 | It's a five-day turnover of 100 percent,

00:18:26.840 | an annual return over of 5,000 percent,

00:18:29.840 | and I'm the kind of person that thinks

00:18:32.280 | three percent of the turnover is kind of pushing him on my side.

00:18:35.960 | And there's a big difference between three percent and 5,000 percent.

00:18:40.760 | So, the trading environment obviously

00:18:43.520 | riches Wall Street and impoverishes therefore the investor.

00:18:47.200 | So, that's why stay the course works.

00:18:50.440 | >> Yeah. There's a wonderful front line from about 50 years ago,

00:18:56.160 | that featured tech funds,

00:18:58.520 | the hot tech funds of the late '90s,

00:19:01.200 | and there was about a 30-second clip of Garrett Van Wagner,

00:19:04.960 | who was a famous tech fund manager at the time,

00:19:07.480 | with one phone in each hand shouting the words to each phone,

00:19:11.720 | and even then it just gave me the willies.

00:19:14.960 | I thought there's something wrong here.

00:19:18.280 | All right. Well, let's shift gears a little bit here and talk about some ladies.

00:19:24.240 | The first lady I want to talk to you about is Mary Jo White.

00:19:29.480 | I have a- we talked about this last night.

00:19:33.280 | I have an odd sense of disquiet about that you pointed out that she is a prosecutor,

00:19:40.080 | and we would hope that she would perhaps use those skills in her job.

00:19:46.720 | But I don't think that's necessarily a good fit for her skills.

00:19:52.640 | I think that the job of being the SEC commissioner is a chairman of the SEC,

00:19:58.600 | is a more broad moral and if you will.

00:20:05.080 | I'm wondering if you have that same sense of disquiet about her.

00:20:08.440 | >> Well, I think she was clearly brought in with the idea,

00:20:12.440 | at least a major part of the appointment.

00:20:14.720 | Leaving aside the fact that most administrations really want to have

00:20:19.200 | more women in them and most of them do these days is that she's a prosecutor,

00:20:23.640 | a tough prosecutor, A, and B,

00:20:26.520 | she knows Wall Street.

00:20:27.560 | She's been a lawyer in there for,

00:20:29.280 | I don't know, 35 years or something, 40.

00:20:33.440 | In that sense, if the mission is prosecute,

00:20:38.280 | get people in jail,

00:20:40.000 | get big penalties, she was a good choice.

00:20:44.760 | Unfortunately, that's a very narrow,

00:20:46.640 | as Bill says, a very narrow version of what the SEC does.

00:20:50.880 | They're there to protect the consumer, the investor.

00:20:54.920 | It's got to be a big complicated business.

00:20:58.200 | They are outgunned at every level by these costs,

00:21:02.960 | by the high-frequency traders.

00:21:04.760 | I don't know who at the SEC can out-talk

00:21:06.960 | the high-frequency traders about that complex business,

00:21:09.880 | which is probably not a bad business,

00:21:11.680 | it's got to be regulated more.

00:21:13.200 | But it's speed in the markets and they had tremendous lead times.

00:21:19.520 | Then she's also affected and people have done very little talk about this.

00:21:24.760 | I talked a little bit about it at the Senate Finance Committee when I testified there on

00:21:29.040 | September 16th as their lead witness and it was about the retirement system.

00:21:33.560 | But I was talking about regulation and the Don Frank law itself,

00:21:38.880 | as well as the Department of Trade Regulations,

00:21:41.600 | are allowed to impose standards of fiduciary duty on

00:21:45.720 | everybody involved in the system except the people that manage money.

00:21:50.780 | How can that be?

00:21:52.520 | I mean, they're not allowed to impose

00:21:54.600 | the standard of fiduciary duty on money managers in either case.

00:21:58.200 | That's ridiculous. That's the most important fiduciary,

00:22:01.720 | the most important toucher of other people's money around.

00:22:04.840 | But she can't go beyond what the Congress gave her.

00:22:07.760 | So I'm trying to make a little excuse for her.

00:22:09.400 | I think she's integrity laden.

00:22:11.120 | I think she's maybe over her head as an administrator of this huge agency.

00:22:15.520 | I think she must struggle each day with figuring

00:22:18.440 | out there's so many things going on in the system.

00:22:21.160 | She must be struggling. I don't know who she has that's

00:22:23.240 | really good in terms of division heads.

00:22:26.040 | I'm not so good. I think the guy who's running the mutual fund division.

00:22:29.120 | I think it's okay, but not a hell-raiser like the ones I used to work with.

00:22:33.200 | We used to go along famously.

00:22:34.600 | I don't even know this guy.

00:22:35.840 | On the other hand, I'm not the preeminent figure anymore.

00:22:38.640 | Yeah. I mean, I guess I expect too much.

00:22:43.640 | When I look out at the brokerage industry and the investment company industry,

00:22:49.080 | I see a moral swamp.

00:22:51.200 | I keep waiting for the person who's the SEC chairperson to deal with that,

00:22:57.160 | and it just never happens.

00:22:59.320 | Mary Jo White, I think,

00:23:01.160 | takes a very legalistic narrow view of things and says,

00:23:04.600 | "Is the law being broken?"

00:23:06.320 | The problem is the law itself.

00:23:08.560 | Unfortunately, the law itself doesn't make it legal,

00:23:11.200 | most of the activities that I think exercise,

00:23:14.360 | Jack, myself.

00:23:17.400 | Well, I'll bring another lady in,

00:23:20.640 | and this is so political that I don't want Mel to hit his ejection button,

00:23:24.480 | so I won't even mention her name.

00:23:26.600 | But this woman, who's a very prominent woman,

00:23:29.920 | has said that the President of the United States

00:23:33.840 | cares more about Wall Street than about Main Street.

00:23:38.760 | I'm wondering what you think about that.

00:23:42.360 | Do you think that's true?

00:23:44.120 | No, I don't think so.

00:23:46.240 | We are wrapped up in an outrageous political system,

00:23:49.920 | where there is so much money coming out of Wall Street,

00:23:53.840 | and you even get somebody, a Democrat, like Chuck Schumer,

00:23:57.080 | who is, I think, I'm not sure which committee he's headed down there with.

00:24:01.440 | He could do something about this outrageous,

00:24:04.400 | this is a really good example of this outrageous tax treatment legislatively,

00:24:09.080 | in which hedge fund managers get

00:24:11.160 | their returns of capital gains rates and not ordinary income rates.

00:24:14.680 | If a Democrat, he should be for that.

00:24:16.840 | Where does Senator Schumer get all his money from? Wall Street.

00:24:21.120 | So even the liberals in Congress don't dare to take on the hedge fund industry.

00:24:26.680 | I think that's wrong.

00:24:28.760 | I think that's tragic,

00:24:30.960 | and I think Obama has talked a little bit about this,

00:24:34.800 | but he's limited by the university's regulations around him,

00:24:40.160 | and he too was supported by Wall Street.

00:24:43.040 | That seems to be fading quite a bit.

00:24:45.280 | I'm not sure anybody's supporting him now,

00:24:47.200 | which probably means he's doing a great job.

00:24:49.800 | Think about that for a minute.

00:24:55.320 | No, I don't think he's against the individual investor at all,

00:24:59.240 | but more in favor of Wall Street than the individual.

00:25:01.640 | He's got the right values.

00:25:04.520 | He seems to maybe be,

00:25:05.760 | as the conventional wisdom tells you these days,

00:25:08.200 | maybe he has a policy of being too deep a thinker and not strong enough an actor,

00:25:13.280 | and not a deep enough thinker and too strong an actor.

00:25:18.720 | So we're somewhat contrasted there.

00:25:21.720 | Okay. Well, let's back up again a little bit.

00:25:27.200 | This time only six years.

00:25:29.440 | I mean, if I could back up 30 years,

00:25:33.920 | and I think for anybody in this room could back up 30 years,

00:25:36.400 | what we would have done is obvious,

00:25:37.800 | which is we would have purchased Microsoft with the IPO we wanted at the beach.

00:25:44.560 | We would have invested in Vanguard funds.

00:25:48.000 | So with that benefit of hindsight,

00:25:52.600 | let's go back to September 15th, 2008.

00:25:58.640 | You have two of the biggest financial corporations in

00:26:04.120 | the world that either are going to go bankrupt or about to go bankrupt.

00:26:08.480 | How would you have handled it differently?

00:26:10.600 | Obviously, it was handled tolerably well.

00:26:13.280 | Knowing what you know now,

00:26:14.800 | what would you have done differently?

00:26:16.840 | Well, I mean, I'm not an expert in why the Fed and New York Fed,

00:26:22.520 | and particularly the Secretary of the Treasury did what they did,

00:26:24.840 | but I think they did what they could do.

00:26:27.280 | They're limited, I happen to believe,

00:26:29.120 | stimulus package from the margin.

00:26:31.440 | There was no, as emerging from the litigation between

00:26:35.760 | Hank Greenberg against AIG or against the government's treatment of AIG.

00:26:40.280 | There's no question that the government had to do something,

00:26:42.400 | and they were on the edge of bankruptcy.

00:26:44.000 | Whether they did it perfectly,

00:26:45.600 | whether people like Goldman Sachs were protected from

00:26:48.760 | taking haircuts on the paper they had with AIG.

00:26:53.320 | I wondered about that then and I wonder about that now.

00:26:56.200 | But I wasn't there.

00:26:58.640 | You have to take into account a lot of things in the financial system.

00:27:03.320 | The lubricate space we do in the US starts to fall apart.

00:27:07.760 | So particularly under pressure,

00:27:09.920 | I don't think you could have done any better.

00:27:12.160 | Sure, little things might have been done better,

00:27:14.680 | but they had to let me even go.

00:27:17.040 | There's arrogant guys up there,

00:27:19.320 | pretty disgraceful the way they handled the finances of that firm,

00:27:22.680 | and they were not the only ones.

00:27:25.720 | I also thought the money market people got off very,

00:27:28.840 | very lightly, faking their asset value,

00:27:32.120 | what they call institutional money markets.

00:27:35.960 | So there are other things that they might have done better,

00:27:40.120 | but that ended up in litigation and the government just didn't win the case.

00:27:43.560 | That's always hard to win when you're outgunned with high-priced lawyers.

00:27:48.120 | So I think in an imperfect world,

00:27:52.400 | that system of financial crisis was handled as well as it could be.

00:27:56.920 | I think that increasingly comes out of the reading of the testimony.

00:27:59.720 | I guess it's now over, the AIG trial.

00:28:03.160 | Yeah. Gene Fama did a very interesting interview about a year ago.

00:28:08.320 | Jeff Summers in the New York Times,

00:28:12.080 | and he said he would have just nationalized banks,

00:28:16.000 | and Jeff Summers, you'd almost see his jaw drop.

00:28:20.320 | He said, "That's not exactly the answer I would expect from a Chicago libertarian."

00:28:25.600 | Fama held his ground, he said, "Yeah,

00:28:28.440 | that's what I would have done."

00:28:31.840 | The interesting thing about that reply, I think,

00:28:34.360 | is that it would have avoided a lot of the political fallout,

00:28:39.960 | people who were angry that the government bailed out Wall Street and not Main Street.

00:28:46.280 | Something else we chatted about briefly last night,

00:28:50.760 | Jack, is obviously we live in a world now that it's a DC world.

00:28:58.680 | It's a defined contribution world.

00:29:00.480 | The BP pensions, the old traditional pensions are slowly going away.

00:29:06.880 | Was the shift from DB to DC,

00:29:13.160 | defined benefit pension plans,

00:29:14.880 | traditional pension plans to defined contribution plans a mistake?

00:29:18.600 | Well, it's not a mistake conceptually because that's the way the world is going.

00:29:24.440 | Corporations want that pressure off their P&Ls.

00:29:28.840 | But it's given us a system that is not working well at all.

00:29:33.000 | It's moved the whole shift of risk from the corporation,

00:29:36.560 | which can handle it presumably,

00:29:38.160 | over to the investor, most of whom cannot handle the risk.

00:29:41.400 | We tried to turn a savings plan,

00:29:47.360 | a trip plan into a retirement plan.

00:29:50.520 | If you have a retirement plan,

00:29:52.360 | I've written a lot about this,

00:29:53.400 | talked about it down at the Senate testimony.

00:29:55.840 | You can't take money out of your retirement plan whenever you want.

00:29:59.600 | You can't borrow from it.

00:30:00.880 | Think of what would happen to Social Security if you could

00:30:02.880 | do all those things. You wouldn't be working for anybody.

00:30:05.720 | The wife needs a new rug,

00:30:07.440 | there goes your retirement. Too bad.

00:30:10.840 | So it's basically the defined contribution system is what we're faced with,

00:30:19.880 | what's going to grow.

00:30:21.080 | I can even see the states and municipalities going from defined benefit.

00:30:25.240 | The governments, state-level governments are the biggest,

00:30:29.200 | by far the biggest defined benefit plans.

00:30:32.120 | They're going to eventually, I think,

00:30:33.840 | go to, well, the labor unions there are so strong.

00:30:37.720 | That's going to be a hard thing to do,

00:30:39.400 | but the economics fit that.

00:30:42.040 | We've got to make a much better defined contribution.

00:30:45.080 | Very difficult to withdraw.

00:30:47.320 | Only allow low-cost funds into the system,

00:30:50.000 | maybe even only index funds.

00:30:51.800 | Easy for me to say,

00:30:53.560 | but the fact of the matter is,

00:30:55.360 | all these defined contribution beneficiaries together,

00:30:59.480 | I think it's around five trillion dollars worth,

00:31:01.880 | own the stock market as a group.

00:31:03.960 | But they're trading with each other back and forth,

00:31:06.160 | buying this fund and that fund and selling others.

00:31:08.920 | They're not going to do nearly as well at paying high costs.

00:31:11.680 | So we have to have those kind of elements in the system,

00:31:14.520 | and we have to have more mandatory contribution rate.

00:31:18.280 | Right now, a corporation can just come out and say,

00:31:20.880 | "I'm not going to pay you anything this year."

00:31:22.320 | That's usually, by the way,

00:31:23.760 | the values in the market are the best they're going to be in a long time.

00:31:27.280 | Because they do this when markets are low,

00:31:29.240 | and because that's business as well.

00:31:32.080 | So it's a lot of fixing.

00:31:33.960 | While I will say this, I'll tell you a little anecdote.

00:31:36.320 | I was doing, that was a 60-year legacy party seminar for a day,

00:31:43.040 | in the Museum of Finance in New York about a year and a half ago.

00:31:48.960 | I did an interview with Paul Volcker at lunch,

00:31:51.480 | and it was a television journalist,

00:31:53.200 | I can't remember who it was, who interviewed us.

00:31:55.380 | She asked me what I thought about Social Security,

00:31:58.040 | and I'd say the same thing about the fine benefit, fine contribution plan.

00:32:03.200 | I said, "Look, it's got to be fixed,

00:32:06.280 | and the fixes are simple.

00:32:08.960 | It would barely be noticed,

00:32:11.040 | maybe not for a long time,

00:32:12.600 | maybe not forever, small changes in cost of living adjustments,

00:32:16.600 | small change in retirement age,

00:32:19.320 | a higher minimum deduction, salary cap,

00:32:23.380 | 115,000, maybe 135,000 or something,

00:32:27.020 | which we did only very few people.

00:32:30.220 | I said, "If you would make all of these czars of the Social Security plan,

00:32:37.540 | I would say czars of the fine contribution plan too.

00:32:40.580 | We'd fix it in an hour."

00:32:42.780 | Paul said, "Couldn't we fix everything?"

00:32:47.560 | I think we probably could,

00:32:51.960 | or at least maybe we could.

00:32:54.080 | I want to turn the tables on you a minute,

00:32:56.760 | Bill, because I've got a couple of questions for you.

00:32:59.440 | I was hoping you would wait after that.

00:33:03.080 | Okay, go ahead.

00:33:05.520 | The line of my questioning comes,

00:33:07.720 | it has to do with the markets.

00:33:09.800 | That is, we can all look at Schiller PEs and regular PEs,

00:33:13.640 | and we can always look ahead to earnings,

00:33:15.280 | which I'm quite confident are quite forced,

00:33:17.860 | and then we'll do, I'll talk a little bit about that later on.

00:33:20.980 | But I was inspired if you're thinking about

00:33:24.300 | staggering risks that we see out there in the world today,

00:33:29.140 | that the market seems to totally ignore.

00:33:31.460 | You've got this terrorism going on in the Middle East,

00:33:33.940 | and the Middle East is more unstable than it's ever been.

00:33:37.380 | I think even more unstable than Lawrence of Arabia for that matter.

00:33:41.460 | But for a long time in Chinese society,

00:33:44.540 | that very religious, in the name of religion,

00:33:48.520 | big crimes are being committed.

00:33:50.860 | This awful thing where someone being beheaded is

00:33:55.820 | somehow a worse thing than someone being shot in the head.

00:33:59.300 | I'm not sure the victim cares that much,

00:34:01.620 | but that's frightening.

00:34:05.060 | Increasing intransigence of China,

00:34:08.340 | and the slowing of growth in China,

00:34:10.220 | and there's slowing of growth in China.

00:34:11.780 | Another problem, Ebola doesn't look like a big problem,

00:34:15.380 | because it doesn't seem to be able to be transmitted like that.

00:34:17.960 | I guess we had the bird flu a few years back,

00:34:19.980 | which was really a dangerous thing,

00:34:21.540 | because it got everywhere.

00:34:23.020 | But disease, unprecedented, unpredictable things.

00:34:26.700 | The weakness in the European economy,

00:34:29.260 | particularly important in the global world.

00:34:32.220 | So there are all kinds of huge risks out there that the market,

00:34:37.620 | it seems to be ignoring as far as I can tell.

00:34:41.100 | So my question to you,

00:34:42.380 | what I did was that when I thought about this,

00:34:43.860 | what could I ask Bill?

00:34:45.400 | I didn't realize he was going to take all my time asking me,

00:34:49.580 | was I got out a copy of his book called The Investor's Manifesto.

00:34:54.700 | It says, "Preparing for prosperity,

00:34:58.460 | Armageddon, and everything in between."

00:35:02.420 | So I immediately went to the index and looked up Armageddon.

00:35:07.500 | It wasn't there. So I thought Bill could tell me what's going to happen.

00:35:12.980 | What I'm describing is almost an Armageddon.

00:35:15.380 | All these risks converge,

00:35:17.500 | almost an Armageddon scenario.

00:35:19.620 | So what do you say about Armageddon?

00:35:23.380 | >> Well, first of all,

00:35:25.100 | that word, the subtitle is all Bill Fulton's fault.

00:35:29.140 | >> I finally figured it out when I found it in the index.

00:35:34.860 | He said, "How does it sound?"

00:35:36.900 | Bill and I said, "Sure."

00:35:39.060 | It sounds good to me, whatever sounds.

00:35:43.100 | But more seriously, I think that human beings are prisoners of saliency.

00:35:51.740 | The image of someone having their head cut off,

00:35:58.900 | the mental image of something bleeding out from their urethras,

00:36:02.060 | from a horrible disease that you really can't treat.

00:36:05.340 | Those are things that really get our attention.

00:36:09.820 | But I think if you were to go back into a time machine to say 70 years ago,

00:36:16.780 | when we were staring down the likes of Hitler and Stalin,

00:36:21.140 | or even 50 years ago,

00:36:24.460 | when one man really saved the world from being incinerated,

00:36:28.780 | it was a man by the name of Vassily Arkhipov who was a commissar on a submarine

00:36:34.060 | who prevented his commanders from pressing a nuclear button on that submarine.

00:36:40.220 | It's a thing you should look up.

00:36:43.860 | It's an interesting story.

00:36:45.140 | I think if you went back and you told people 50 or 70 years ago,

00:36:49.460 | the biggest threat we have now is from people who want to go back to the 7th century

00:36:54.300 | and can't even manufacture their own bicycles.

00:36:57.220 | I think they would have laughed at us.

00:36:59.420 | I think the problems that we're facing now are trivial compared to those problems.

00:37:06.860 | And I think that's one of the reasons why expected returns,

00:37:10.220 | why prices are so high and why expected returns are lower.

00:37:14.260 | Now the other reason why that's the case and has nothing to do with risk

00:37:18.500 | is simply the fact that there's a lot more capital in the world.

00:37:21.780 | And this is a complex subject,

00:37:24.940 | but if you go back 5,000 years, nobody had capital.

00:37:29.340 | We're talking about subsistence level societies.

00:37:33.100 | And the people needed capital.

00:37:34.740 | They needed to buy farm implements and buy seed.

00:37:38.180 | So that one person who had capital could get an enormous price for it.

00:37:44.300 | And as societies become wealthier, that physics, if you will, changes.

00:37:48.660 | So the richer a society becomes, the lower the returns.

00:37:52.460 | And maybe the returns we're going to get really aren't commensurate with the risks.

00:37:57.420 | I think that's right.

00:37:58.980 | I think the problem is not that risks are so high.

00:38:02.100 | I don't think they are high compared to the world 50 or 70 or 80 years ago.

00:38:06.860 | I just think that the returns are so low commensurate with the relatively small risks that we have.

00:38:11.900 | You know, that's something that I was going to ask you about,

00:38:15.700 | but I'll comment upon and maybe get a response from you, Jack,

00:38:20.100 | which is that, and I'm sure you'll talk about this more later on this morning,

00:38:25.180 | is if you look at the expected return of a prudent mixed portfolio, a 60/40 portfolio,

00:38:31.940 | it's lower than it's ever been in human history.

00:38:35.140 | You know, zero return on bonds, maybe a 3% or 4% return on stocks.

00:38:40.660 | That's not much more than 2% real return on your capital.

00:38:46.460 | And that, I think, is really the worrisome thing for people who want to retire.

00:38:53.020 | You've got this squeeze, if you will, between lower returns,

00:38:57.340 | and then people are going to be living longer.

00:38:58.780 | I've been looking at some of the younger people in this audience,

00:39:01.300 | and you know, you're going to live to be 100.

00:39:04.100 | If you want to retire at age 55, you'd better--

00:39:05.900 | What do you mean only the younger people are going to live to be 100?

00:39:10.220 | I've been talking to a cop for this for six.

00:39:13.340 | They're going to have a better chance than I do, that's for sure.

00:39:17.500 | And you know, if they want to retire at age 55,

00:39:22.380 | well, maybe people in this room will do it, but not many other people will.

00:39:29.500 | Well, the interesting thing is that we see whatever it is we see,

00:39:33.540 | I have to be really concerned about the state of the world today.

00:39:36.980 | And I don't quite, myself, know what to do about it.

00:39:39.180 | I mean, I could go heavily into cash, as always, you know,

00:39:42.380 | roughly in this day and age, probably 60 percent stock, 65,

00:39:46.740 | something like that, counting all the different accounts I have.

00:39:49.300 | My retirement plan would be higher, that's my biggest asset.

00:39:52.220 | And my personal account would be lower.

00:39:55.220 | But personal account is mostly intermediate-term munis.

00:39:58.540 | So I'm happy to be there, as happy as I could be this year.

00:40:02.220 | As I've ever been, you know, 8 percent return,

00:40:04.020 | most of which is tax-free, is not to be seized at.

00:40:07.180 | So, but I still puzzle that the big risks are undefined and out there somewhere.

00:40:15.700 | And that kind of a situation basically doesn't get a response from the stock market.

00:40:22.340 | And whether it should or not,

00:40:24.940 | I mean, I happen to know one particular investment advisor who has all his clients,

00:40:29.700 | has had for years, 60 percent short-term treasures.

00:40:33.460 | And he says he knows the event is coming,

00:40:36.100 | he's got to be ready, he's got to protect our assets,

00:40:39.100 | that they have to give up a few gains or a lot of gains in

00:40:42.340 | the search for protection when the great day or the bad day or the evil day comes.

00:40:49.660 | Well, that's the way it is.

00:40:51.460 | Now, I'm not sure that's a viable strategy.

00:40:53.940 | I think his clients would get a little wondering if he knows what he's doing.

00:40:59.500 | But if you're ahead of the crowd,

00:41:01.340 | people are always going to wonder what you're doing.

00:41:04.420 | So, I don't have any answers to it either,

00:41:06.980 | but I do think that everybody in the room,

00:41:09.340 | I would feel very guilty if I didn't warn everybody that this is a risky,

00:41:14.460 | risky world we live in.

00:41:16.220 | And I don't know what to do about it except a reasonable conservative position.

00:41:22.140 | And Armageddon is, I tell people,

00:41:25.460 | if Armageddon is having some kind of a foreign object strike the US,

00:41:32.740 | well, it won't matter whether you're in stocks or bonds.

00:41:35.740 | That's the good news.

00:41:38.020 | Or to put a little top on that,

00:41:40.300 | I reviewed this in a different context earlier.

00:41:43.220 | We all know the world is going to hell in a handbasket,

00:41:47.140 | but it never quite gets there.

00:41:49.260 | Never quite gets there.

00:41:50.940 | So, I think you should be aware of risk.

00:41:53.620 | I don't know what to tell you to do about it.

00:41:54.860 | I don't know what to tell myself to do about it.

00:41:56.820 | When I start to panic,

00:41:58.460 | I would just read one of my books.

00:42:01.020 | [laughter]

00:42:04.300 | Thanks, Jack and thanks, Bill.

00:42:05.900 | And we're going to take a short break now.

00:42:07.980 | And in 20 minutes, Jack will start his comments.

00:42:12.580 | [applause]

00:42:20.700 | [silence]

00:42:25.700 | [BLANK_AUDIO]

Bogleheads® Conference 2014 -John Bogle & Bill Bernstein Fireside Chat

Chapters