Bogleheads® on Investing Podcast 001 – John C. Bogle, host Rick Ferri (audio only)

00:00:00.000 | [music]

00:00:06.000 | Hello, everyone, and welcome to Bogleheads on Investing, podcast episode number one.

00:00:17.680 | On this inaugural episode, we have a very special guest, John C. Bogle, founder of the

00:00:24.240 | Vanguard Group and creator of the World's First Index Fund.

00:00:30.400 | [music]

00:00:37.360 | Hi, everyone. My name is Rick Ferry, and I am the host of Bogleheads on Investing. This

00:00:44.640 | podcast is made available by the John C. Bogle Center for Financial Literacy, a 501(c)(3)

00:00:53.560 | foundation.

00:00:55.360 | On each episode, we'll dive deep into the principles of low-fee investing and other

00:01:01.040 | financial topics of interest with a special guest. All episodes can be found on Bogleheads.org

00:01:08.720 | and the Bogleheads Wiki site. They will also be available on commercial sites such as iTunes

00:01:15.840 | and SoundCloud.

00:01:18.560 | Ladies and gentlemen, today I have with us none other than the man who started it all,

00:01:23.880 | Mr. John C. Bogle. Let me read to you what Mel Lindauer said when he introduced Mr. Bogle

00:01:30.760 | a few years ago at our investing conference. While some mutual fund managers choose to

00:01:36.400 | make billions, Jack Bogle chose to make a difference. And I think that exemplifies more

00:01:42.960 | than anything our guest today. Good morning, Mr. Bogle. How are you today?

00:01:48.560 | Rick, good morning. Please call me Jack.

00:01:51.080 | Thank you. I had the unique opportunity to review your upcoming book, Stay the Course,

00:01:59.840 | the story of Vanguard and the index revolution. We're going to be talking a lot about that

00:02:05.520 | book today. It's a great history of not only Vanguard but of your life as well. I highly

00:02:13.240 | recommend when it comes out in November that everyone read it because it's just extremely

00:02:19.680 | thorough and a great read for anyone who is interested in the history of Vanguard and

00:02:25.720 | in how you got to create this great company.

00:02:28.800 | Let me read one of the quotes from the book to get this started. And this is from Warren

00:02:34.320 | Buffett, the Oracle of Omaha, who at the 2017 annual shareholder meeting, which you and

00:02:42.240 | some of your family members attended, said this to the audience of 40,000, Jack Bogle

00:02:48.840 | has probably done more for the American investor than any man in the country. Jack, could you

00:02:55.840 | stand up? And then what happened, Mr. Bogle, or Jack, what happened after that?

00:03:00.720 | Well, I'm a little embarrassed to say so. There was an explosion of applause. It seemed

00:03:07.480 | like everybody in the audience knew about me. And Warren had prefaced his remarks by

00:03:12.640 | saying there ought to be a statue for me. And there happens to be one here in Valley

00:03:18.800 | Forge. That's another point. But it was embarrassing and exciting and very uplifting.

00:03:27.920 | Was that the first annual meeting you had been to?

00:03:30.600 | Yes, it is. First annual meeting of Berkshire.

00:03:34.160 | But Mr. Buffett is not new to indexing. In fact, back in 1996, he wrote in his annual

00:03:40.080 | report for Berkshire Hathaway, this quote, "Most investors, both institutional and individual,

00:03:46.680 | will find that the best way to own common stocks is through an index fund that charges

00:03:51.000 | minimal fees. Those following this path are sure to beat the net results after fees and

00:03:56.360 | expenses delivered by a great majority of investment professionals." So he was not

00:04:02.040 | new to indexing. He's been a fan of yours for a long, long time.

00:04:05.640 | Well, that's 22 years ago, Rick. And I think he was a great profit, P-R-O-P-H-E-T, because

00:04:15.600 | the people that listened to him earned great profits, P-R-O-F-I-T.

00:04:20.360 | There was a lot going on, though, in 1996 in your life and also at Vanguard. The first

00:04:27.000 | time I ever heard you speak was in May of 1996. I was at the Atlanta CFA Institute annual

00:04:34.000 | conference. And at that time, I was a newly minted CFA for about a year and a half. And

00:04:41.520 | I was really having a difficult time with active management. I had done a lot of work

00:04:47.000 | analyzing the performance of active managers. And it wasn't coming out the way, I guess,

00:04:52.640 | CFAs were expecting it to come out, which was, if you're a CFA and you're picking stocks,

00:04:58.920 | you're supposed to outperform. That's sort of what the CFA Institute was all about.

00:05:02.960 | Anyway, I'm listening to all the different speakers talking about all the different ways

00:05:06.920 | we could outperform. And then you got up on stage. And I remember it quite clearly. You

00:05:11.840 | said that this was the first public appearance that you made after having your heart transplant.

00:05:17.360 | It was pretty exciting to be back on my feet again, Rick. My son, John Vogel, Jr., was

00:05:25.280 | the moderator. There were two people, an active manager, I think, and me. And the moderator

00:05:30.760 | was my son, John Vogel. That was pretty exciting. And if I can add a little family anecdote,

00:05:39.200 | my birthday took place, regular birthday, on May 8th, a few weeks later. And he gave

00:05:47.580 | me a present down there. We had a nice little family dinner together. He gave me a squash

00:05:52.840 | racket. And my wife almost fainted. She didn't think I should ever get back on the squash

00:05:57.720 | court. But two weeks later, I was back on the squash court.

00:06:01.200 | Wow, that's great.

00:06:02.200 | And I don't do that anymore, but I had a couple of decades of playing squash. And it's been

00:06:11.800 | quite remarkable and fun and productive, I think, for me to be given an extra 21 years

00:06:19.200 | of life.

00:06:20.200 | And hopefully many more.

00:06:22.120 | I hope so. But the old body is, the spirit is willing, Rick, but the flesh is weak.

00:06:28.120 | Well, I could tell you, but the mind is still there. There's no doubt about that. Okay.

00:06:33.200 | So what happened was, you got up there and you started talking to all of these CFAs,

00:06:36.640 | who have all been trained to believe they can outperform the market if they work hard

00:06:41.440 | enough. And you got up there and you started giving us the facts. And it was pretty blunt,

00:06:47.680 | very straightforward, not any different than what you have been saying ever since. And

00:06:54.360 | basically straight out of your book, the first book that you wrote back in 1993 called Vogel

00:06:59.000 | on Mutual Funds, with probably a little bit more detail than even what was in that book.

00:07:03.840 | And I was sitting there listening to this saying, I just went through this long CFA

00:07:09.080 | educational process where I've been trained to believe that if I work hard, I can beat

00:07:13.160 | the market. And he's telling me that I can't. And that's exactly what I'm seeing in my data

00:07:18.000 | as well, as I analyze money managers and mutual funds.

00:07:21.200 | I've got to pick up a copy of his book and I've got to read this because there's probably

00:07:24.640 | something in it. And I did do that, by the way, I did it in October of 1996. So a few

00:07:31.520 | months later, I bought the book. And I can remember very clearly when I had my epiphany,

00:07:39.000 | my big aha moment. It was at a House of Horrors event where my children were going through

00:07:46.280 | this House of Horrors right before Halloween. And there was this fake chainsaw in the background

00:07:51.080 | and lots of screaming and yelling. And I was sitting in the car waiting for them. And I

00:07:54.480 | had the light on and I was reading your book. And I came to some passages in that book which

00:07:58.360 | just absolutely blew my mind because you were saying in that book absolutely exactly what

00:08:06.880 | I was seeing in the data that I was analyzing on Mutual Funds. I mean, to the penny. And

00:08:14.040 | at that point, I realized, I had an epiphany. I realized that I was not alone. That in fact,

00:08:22.160 | there was a lot of other people out there like me who just didn't believe, that knew

00:08:28.880 | that something was wrong and you were doing something about it. And that literally for

00:08:33.680 | me, it changed my life. And it changed the direction that I went in my career. And for

00:08:39.440 | that, of course, I greatly thank you. And I just wanted to tell you that story that

00:08:43.480 | seeing you that first time after you had your change of heart, as you called it, caused

00:08:48.320 | me to take a path that actually changed my life.

00:08:51.040 | I appreciate that, Rick. I do my best. And that book was an interesting book. Up to that

00:08:58.280 | time, I think it's fair to say there was not a single book on Mutual Funds or a single

00:09:04.200 | book that looked at them from those various directions. Certainly, that's true. And I

00:09:09.760 | was recommended as the writer by the head of the CFA and to a nice young woman named

00:09:16.040 | Amy Hollins who worked for Dow Jones Irwin Publishing, a big publishing house of the

00:09:21.640 | day. And she came to me a couple of years earlier and then again and then again asking

00:09:27.560 | me to write the book. She said, "Everybody says I'm the only one that can do it." She

00:09:31.920 | was being flattering. We men like that when women flatter us. But I said, "Look, I'm trying

00:09:38.680 | to run a business. My health is terrible. I just can't do it. I'd like to." But when

00:09:43.940 | she came in 1990, I think 1992, she'd come each autumn and came in 1992, and I said,

00:09:52.480 | "I've decided I'm going to write the book. I'll have to work weekends so I don't disturb

00:09:57.880 | my business stuff. And I'm afraid that I may not live long enough to put it off any longer

00:10:04.720 | because I've had trouble with my heart since I was 30 years old when I had my first heart

00:10:10.680 | attack." So I did it. It was a tremendous success publication-wise. And it said what

00:10:17.360 | I wanted to say. And I look at it every once in a while, and I'm pretty happy with that

00:10:22.560 | book actually written. To be candid, I'm not sure I've ever written another book that is

00:10:29.200 | that good.

00:10:31.200 | Well, I would say that that book had the biggest impact. You've written some other books that

00:10:35.000 | have had a big impact, but the shockwave that that book sent out through the industry and

00:10:41.560 | outside the industry was tremendous. Like I said, it changed lives. But 1996 was also

00:10:46.880 | a difficult year for you as well because starting to get into your book a little bit, that was

00:10:51.880 | a transition year for Vanguard.

00:10:53.680 | Yes, it was.

00:10:55.360 | That was the year that you actually had to step down as the CEO. And I have some question

00:11:00.640 | about that. You were 65 years old at the time, and you had heart issues. So you stepped down.

00:11:09.120 | There's a rumor out there, and I just want to clear it up whether it's true or not. Did

00:11:11.520 | you actually have something in the bylaws at Vanguard that said that at 65, you had

00:11:16.040 | to retire?

00:11:17.040 | Absolutely not.

00:11:18.040 | Oh, okay.

00:11:19.040 | Well, for two reasons. First, my health was extremely uncertain. Many, many years before,

00:11:27.200 | one doctor told me I would probably not live till I was 40. And I've struggled with it

00:11:33.000 | all those years in and out of hospitals, whether it's in Boston or Philadelphia or Bryn Mawr,

00:11:39.800 | Pennsylvania, wherever it might be. And I thought I owed it to the shareholders to make

00:11:45.640 | sure that there was a continuity of management. So that was the first thing I was dealing

00:11:51.480 | with hard.

00:11:52.480 | And second, you know, sometimes in this world, we get older, and we aren't quite aware of

00:11:57.640 | it, and we overrate what we can do. And the aging process, although I didn't feel it personally,

00:12:05.720 | was something that was very much in my mind. I thought it was time for the old guys to

00:12:10.000 | make room for younger guys.

00:12:12.720 | But by that time, Vanguard was the second largest mutual fund company behind Fidelity

00:12:17.960 | at the time. So you had really grown the company. And you had also, by that time, introduced

00:12:24.880 | all of the basic broad market index funds, everything from the total market to a bond

00:12:33.880 | fund. I think the REIT fund was introduced in '96, the total international index fund.

00:12:38.720 | So you had the portfolio of index funds were in place at the time. The framework was in

00:12:45.920 | place at Vanguard to bring that company forward. Isn't that correct?

00:12:52.560 | Well, you're absolutely right. So you could say that another thing that was on my mind

00:12:57.840 | was the fact that I put together the basics, the index basics, for the entire enterprise

00:13:05.240 | in terms of centrality and acceptance. They were all there. So the die was cast, if you

00:13:13.160 | will. And those funds that you identify, total stock market, 500, total bond market, total

00:13:20.440 | international, all those funds that I started are our largest funds today.

00:13:26.720 | Which is interesting, Rick, and that is we're talking over a decade ago, and we have had

00:13:33.120 | no innovation in any of those funds. They're the same as they were then. Try and tell that

00:13:38.440 | to Steve Jobs or the guys at Google, a company with no innovation in its basic product line

00:13:45.480 | for what would now be 12 years or 14 years.

00:13:48.680 | No, and I'll have to tell you something else, too. It's something else I learned from you

00:13:52.080 | more recently than when I first had the epiphany and started converting all of my business

00:13:58.040 | and such to indexing was that those funds, those core funds that we talked about, are

00:14:04.040 | all you need. As I get older, and I just turned 60 this year, my thinking has been shifting

00:14:11.160 | even more and more to the way you've been talking about, even though I've been a follower

00:14:15.720 | of yours for almost 22 years, 23 years, and I made the switch that long ago, I am only

00:14:22.360 | now beginning to see the true genius of what you've done as far as...

00:14:27.400 | Thank you.

00:14:28.880 | As far as the simple, broad market index funds in the U.S. and the bond market, maybe international,

00:14:37.000 | maybe some real estate, just very simple index fund portfolio is all you really need. And

00:14:45.520 | everything else is just icing on the cake or the flavor of the icing on the cake that

00:14:50.200 | probably costs you more money and in the end probably doesn't do anything more for you.

00:14:56.280 | You make a good point. Staying the course, the name of the book, or stay the course is

00:15:01.280 | all about buying something that's solid, well-diversified, and holding on to it forever. And to give the

00:15:08.480 | usual phrase that I do, Rick, that follows that, to enjoy the miracle of the compounding

00:15:13.360 | returns without it being eaten away by the tyranny of compounding investment costs.

00:15:20.560 | If you want to think of anything, someone once said, "All this poor guy Vogel has going

00:15:25.920 | for him is an uncanny ability to recognize the obvious." And I think that's fair. They

00:15:32.680 | may have thought it was a criticism. I think it may well be a compliment.

00:15:36.560 | Well, you call this the index revolution in your book, and I think that's what it was.

00:15:41.800 | You also are trying to coin another phrase, and I want to bring that out so that we can

00:15:45.920 | all understand what that is. You've been working on coining a phrase called TIF, or Traditional

00:15:50.760 | Index Funds, and I want you to explain what you mean by that relative to all other index

00:15:58.040 | funds.

00:15:59.040 | Well, I'm delighted to do it because I've tried it about 10 times, 10 speeches, maybe

00:16:05.420 | in public appearances, and it has yet to be adopted. I wanted to contrast ETFs with TIS,

00:16:14.240 | Exchange Traded Funds, with Traditional Index Funds. The basic difference, Rick, is Traditional

00:16:23.000 | Index Funds are passive funds held by passive investors, and Exchange Traded Funds are passive

00:16:32.320 | funds held by active investors. Therein lies a world of difference.

00:16:38.320 | What the statistical services do is talk about ETFs and then mutual funds, so they mix, in

00:16:44.760 | the other part of the equation, they mix index funds, Traditional Index Funds, with actively

00:16:52.480 | managed funds. I mean, it makes absolutely no sense. I tried, I wrote to all the leaders

00:16:58.360 | of the statistical thing about a year ago and said, "Here's what you have to do. Here's

00:17:02.560 | what the data look like," and I didn't even get a single answer to my letter.

00:17:08.100 | They didn't answer you? Interesting.

00:17:10.040 | But I haven't given up hope, you know me.

00:17:12.680 | Okay, well, I have a thought on this, okay, because I did read into this a little bit.

00:17:18.280 | When I first heard you say Traditional Index Funds, my mind said the Vanguard, say, Total

00:17:25.760 | Stock Market, or an S&P 500 that tracks a market index and only tries to achieve the

00:17:32.720 | return of the market index. I didn't differentiate in my mind whether it was a mutual fund or

00:17:40.560 | whether that was done in an exchange-traded fund because, to me, it was the strategy of

00:17:46.400 | the fund itself where you have traditional index funds and then you have all of these

00:17:51.920 | other factor funds and everything else that's trying to, active management that's trying

00:17:57.520 | to make believe that it's an index for the purpose of confusing people.

00:18:02.520 | So that was what I thought when I first read and first heard you talking about TIF. I think

00:18:09.200 | that might be some of the confusion there.

00:18:11.480 | Well, I'm working on it, and I try to explain it a little more fully because it's not an

00:18:18.280 | oral black-and-white thing. Let me try this one. There are 1,000 ETFs that are concentrated

00:18:25.520 | in a special areas, buy short, long short, a single country and on, 1,000 out of 2,000.

00:18:32.680 | This data is a little bit old. And 63% in diversified U.S. stocks. In the traditional

00:18:40.160 | index area, there are 69 diversified U.S. stocks and only 140 trading funds. So the

00:18:49.100 | distinction is quite clear. And when you look at the data, you see that ETFs, over half

00:18:55.600 | of their assets is in either factor funds or concentrated or speculative funds, where

00:19:02.280 | only 10% of the assets, maybe 12% of such funds, the factors, the smart betas, the concentrated

00:19:10.960 | and the speculative, 10% of the assets are in those kind of funds in traditional index

00:19:16.080 | fund form.

00:19:17.080 | So it's not a clean break, but it's an obvious break. And I'm going to keep after TIS until

00:19:23.720 | the day I die. So stand back, world.

00:19:27.340 | Okay. We have been warned. All right. Well, let's go ahead and continue to get into your

00:19:32.480 | book. "Stay the Course. The Story of Vanguard and the Index Revolution." There were four

00:19:38.360 | parts to it. The history of Vanguard, the Vanguard funds themselves, which I found very

00:19:43.800 | interesting. Then looking ahead and a concluding memoir.

00:19:51.120 | Now here is something that you wrote, which I find interesting, and I think it might typify

00:19:56.440 | your association with Vanguard, with the company Vanguard. You wrote in here that when you

00:20:02.080 | were writing this book, that you requested to review the corporate minutes of the Vanguard

00:20:07.200 | mutual funds during the long period which you served as a chairman, but that was denied

00:20:13.080 | by Vanguard. You know, a lot of people think that you still run Vanguard in many ways.

00:20:18.080 | I get letters from them every day.

00:20:20.000 | From people who are asking you to fix things at Vanguard?

00:20:22.480 | Yeah, exactly.

00:20:23.480 | All right. So maybe I can rephrase this to, you know, what is your current relationship

00:20:27.760 | with Vanguard? I mean, how does it work?

00:20:29.800 | Well, and to be candid, I don't have much of a relationship with Vanguard because I'm

00:20:38.160 | out. I don't participate in the management at all. I think that's appropriate. I'm not

00:20:44.160 | complaining about it. I get no information. The shareholder writes me. I have no access

00:20:49.280 | to their records, but that's fine because I don't run the place anymore. I moved over

00:20:55.200 | to let other people run it, and they are running it. So they don't, I mean, I think if they

00:21:00.720 | ever want my advice, they know they can get it any time, but, you know, they think they

00:21:06.840 | know more because they're in the business currently on a daily basis. I have no doubt

00:21:12.880 | they think they know more than I do, and they certainly know more than I do about the current

00:21:17.040 | moments in the business, cash flows, things of that nature.

00:21:20.800 | Oh, I must say, there's so much public information that I'm still very well informed about those

00:21:26.000 | areas, but look, when you retire from the, I don't even want to use the word retire because

00:21:31.960 | I'm anything but retired, but when you leave the position of chief executive, even if you're

00:21:37.200 | the founder of the firm, and that's an important distinction, the new guys want to take over,

00:21:43.960 | should take over, and the old guys should move out of the way. I didn't want to move

00:21:49.600 | out of the way because the founder, I think, is in a different position than a mere previous

00:21:53.760 | CEO, and it's certainly true, as you suggest, that I am still, for better or worse, the

00:22:02.320 | face of Vanguard to many, many people, many shareholders, the public, the media, and so

00:22:07.520 | on.

00:22:08.520 | Well, that's a great answer. Thank you, Jack. I'm going to get back to your book and start

00:22:14.320 | talking about where it all began, which in your book, you start talking about Princeton

00:22:19.960 | and your 1951 essay, and you referenced that as the beginning of your introduction and

00:22:28.880 | analysis, and quite detailed analysis because I read the thesis a few years ago, of the

00:22:34.480 | mutual fund industry as it was back then, and in your thesis, you talk about one mutual

00:22:43.280 | fund company. You talk about a lot of them, but one of them you talked about was Wellington,

00:22:48.280 | and at the time, Walter Morgan, Mr. Morgan, was the president or the CEO, founder of Wellington.

00:22:55.960 | CEO and founder.

00:22:57.640 | Yes, and also, something I didn't know until I read your book, he is also a Princeton graduate,

00:23:03.760 | class of 1920. That's going to be 1920. Well, I'm 100 years ahead.

00:23:09.240 | 1920. I met Mr. Morgan when he was 50 and knew him for 50 years. He died about three

00:23:17.280 | weeks after his 100th birthday. A great man.

00:23:21.660 | Did you meet him while you were writing your thesis?

00:23:26.240 | It's possible that I did because I met him on the Princeton campus, but we didn't have

00:23:31.760 | any discussion about the nature of the business or anything like that until I sent him a copy

00:23:35.400 | of the thesis afterward.

00:23:37.560 | There was a lot of analysis in your thesis about the mutual fund industry at the time,

00:23:42.600 | and you must imagine that when you were writing that thesis, you went to these mutual fund

00:23:46.080 | companies, which at the time were different than they are now. Most of the mutual funds,

00:23:49.440 | as you wrote in your book, mutual fund companies just basically had one fund. They were started

00:23:54.480 | to manage one fund as opposed to the way the fund industry now is where fund companies

00:24:00.280 | have multiple, multiple funds.

00:24:03.640 | I didn't have an opportunity to visit people. I called them mostly on the phone. I did visit

00:24:09.320 | one fund manager for Calvin Bullock in New York because my uncle knew him, and we had

00:24:16.200 | lunch together up there in the New York Bankers Club, but I did not get a lot of input from

00:24:24.040 | the industry people themselves. I got what I could from the ICI, which was next to nothing,

00:24:30.000 | and then I got a lot from the admittedly limited coverage in the media, but the whole history

00:24:39.920 | of the industry as told in the Investment Company Act of 1940 through the hearings that

00:24:44.840 | were held in 1939 and 1940, so I had a lot of input, a lot of facts, a lot of chances

00:24:50.680 | to make up my mind.

00:24:52.840 | I also relied, I should add, I don't know if you'll remember this or not, but we used

00:24:57.600 | to have the Wiesenberger Annual Publication called Investment Companies.

00:25:02.200 | Yeah, I remember.

00:25:03.200 | It came out every year.

00:25:04.200 | I'm that old. Yes, I remember.

00:25:06.800 | And it had the performance records of every fund year by year. In those days, performance

00:25:11.720 | was not something that was kind of right out there for everybody to look at. It was not

00:25:16.520 | a big deal, if you will.

00:25:19.200 | At the time, 1951, what was the benchmark?

00:25:23.640 | The average that people looked at was the Dow Jones Industrial Average, right there,

00:25:29.240 | and that's a very imperfect index, as you know. In the long run, of course, it gives

00:25:34.440 | returns similar to the S&P 500, but in the short run, it's very tricky, sometimes better,

00:25:40.520 | sometimes worse, and on a daily basis, it can be absolutely crazy because it's only

00:25:46.440 | got 30 stocks and they're weighted by price, so a high-priced stock does some big jumping

00:25:51.240 | around and it's changed a lot. It was a happy day when we picked the S&P 500 as the basis

00:25:58.880 | for our index fund.

00:26:01.960 | I actually talked with people over at S&P when you negotiated that contract, and I think

00:26:09.400 | David Blitzer, who was the head of the S&P committee, I was speaking with him. I believe

00:26:16.280 | that he told me a story that you came in and said, "We'd like to license the S&P 500 and

00:26:23.120 | make a fund out of it," and they didn't know what to do because nobody had really come

00:26:28.320 | to them with that, and you had to try to negotiate how much they were going to charge you to

00:26:34.120 | do that, and I recall a number of about $25,000 a year they just threw out there, and you

00:26:40.720 | said, "Okay." Is that how it worked? Is that how it happened?

00:26:44.520 | It's pretty close, although as a sideline, David, and I think I'm quoting him accurately,

00:26:51.720 | and David said in retrospect what they were really thinking then was how much were we

00:26:56.600 | going to charge them for giving this new attention to the S&P 500?

00:27:02.060 | You have.

00:27:03.060 | It's all changed now, but their fees are outrageous.

00:27:05.400 | Yeah, well, it's become a big business, indexing now that index funds are licensing, fund companies

00:27:11.320 | are licensing indexes. Of course, that is their business now, so all the indexes that

00:27:15.440 | are created are created for the sole purpose of becoming a product as opposed to measuring

00:27:20.600 | something or something of economic value, so things have really changed in the indexing

00:27:24.760 | industry as well, which speaks to, by the way, the difference between, in my mind, a

00:27:29.440 | traditional index versus these other things, and that's what I was thinking, getting back

00:27:35.040 | to your traditional index fund concept.

00:27:37.520 | Well, the traditional index funds, you're right, and I may have not done a good job

00:27:42.920 | in articulating the difference, but basically, the true traditional index funds, and we're

00:27:50.680 | trying to make a mix, it's not necessarily easy to make, but they're funds that are designed

00:27:56.880 | to be bought and held forever, and that means very large, broadly diversified funds, 500

00:28:04.240 | post-stock market, total international, maybe total emerging markets, and total bond market,

00:28:11.000 | and now you can do reasonable variations on that, and one of the obvious ones is municipal

00:28:16.980 | bonds are not included in that bond market, and a lot of wealthy people, a lot of potential

00:28:21.320 | clients need municipal bond funds, and so you have to have a long and an intermediate

00:28:27.480 | in short, that's the concept we introduced here at Vanguard in 1974, I think, and making

00:28:36.120 | the investor choose between long, intermediate, and short.

00:28:39.120 | The muni-municipal bond industry doesn't really have a very good index, so it's an index fund

00:28:44.200 | without being a formal index fund.

00:28:46.240 | It has an extremely high correlation with the index, as you see, but they're very hard

00:28:51.840 | to match because the municipal bond has so many different areas of so many little bonds

00:28:57.360 | and different call provisions and all that, and it's worked very, very well.

00:29:02.800 | Our muni funds, long, intermediate, and short, and limited term, have a very high correlation,

00:29:08.400 | certainly in the mid-90s, with the indexes as they exist, so they're quasi-index funds

00:29:15.120 | or something like that.

00:29:16.120 | Well, I can tell you a story about those funds, those three funds.

00:29:19.520 | I used to manage several hundred million dollars of municipal bonds for clients of mine, and

00:29:26.680 | they were all basic bond ladders from one to 10 years, state-specific and all of that,

00:29:31.860 | and I was looking for a benchmark to determine how I should rate my performance as a manager

00:29:38.360 | of municipal bonds to the general municipal bond market.

00:29:43.080 | I could not find a municipal bond index that worked, so I used a combination of the Vanguard

00:29:51.080 | Limited Term Municipal Bond Fund and Intermediate Term Municipal Bond Fund, which the duration,

00:29:59.080 | the average maturity, if you will, of those funds combined equaled what my portfolio looked

00:30:05.560 | like, and so I was able to benchmark my portfolio of municipal bonds to something that was a

00:30:13.040 | better index of municipal bonds than the indexes themselves, and by the way, because of that,

00:30:19.640 | I stopped managing municipal bonds and went to all Vanguard bond funds.

00:30:24.400 | Yeah.

00:30:25.400 | Well, it's hard to beat the deal, because trading costs in the municipal bond business

00:30:29.240 | are very high, as you know, but we have become, through that idea of long, intermediate, and

00:30:37.200 | short gave us an important role, we were late entrant, as you read in the book, late entrant

00:30:43.400 | into the municipal bond area, and all of a sudden, we changed the way the bond industry,

00:30:48.960 | bond fund industry worked.

00:30:51.100 | Everybody went to long, intermediate, short, and it's so much smarter, so much better for

00:30:55.960 | the client, and so much greater clarity as to whether a fund is doing well or ill.

00:31:03.640 | I have to add, Rick, that I was not unaware an index or whatever it might be in the segments,

00:31:10.120 | like long, intermediate, and short, the more important low cost becomes.

00:31:15.600 | Low cost is a very valuable differentiator in the total municipal bond market, but an

00:31:22.400 | invaluable, totally invaluable, extremely deterministic, really, when you break down

00:31:28.920 | the market by maturities, holding quality constant.

00:31:33.920 | Well these things that we take for granted now, when we look back and see where they

00:31:37.920 | came from, a lot of the great innovations that are out there today that everyone is

00:31:42.120 | using have come from you and your work at Vanguard, which is amazing in itself, and

00:31:47.760 | as I read the book, all of this comes out, the first factor funds, you know, the value

00:31:52.480 | and growth, you were the first to come out with that.

00:31:54.280 | Funny story, we have in this day a factor fund, which by and large I do not approve

00:32:00.080 | of.

00:32:01.080 | I don't think there are factors that are permanently good.

00:32:04.600 | So why are we the starters, the creators of the first growth index fund and the first

00:32:10.920 | value index fund, both of which are the two largest factor funds in the field according

00:32:16.080 | to Morningstar, by far, and the reason I did it had nothing to do with one doing better

00:32:20.920 | than the other.

00:32:21.920 | And if you look at my annual reports written to the shareholders in those days, it said,

00:32:26.720 | look, it's really designed to accumulate money on the growth side, in the growth index, and

00:32:33.080 | have a very low taxable tax rate.

00:32:36.000 | And then when you retire, you can move over to the value side and have a little less volatility

00:32:43.360 | and more income.

00:32:44.360 | It was a financial planning kind of an idea.

00:32:47.880 | And I said, don't try and pick one over the other for performance, because I'm going to

00:32:52.760 | tell you that the most likely event is that they will both have the same returns over

00:32:57.680 | the next 25 years, or I'm not sure I used 25 year period, same long run returns.

00:33:03.320 | Well, 25 years later, they both had returns of 9%.

00:33:09.200 | And the devil in the detail is that investors didn't do what I told them, traded them back

00:33:15.180 | and forth, and don't hold me to this exact number, but I think investors in the value

00:33:20.800 | fund had a return of about 5%, investors compared to the funds themselves, and investors in

00:33:26.400 | the growth fund had a return of about 7%.

00:33:29.800 | That would be 4 percentage points and 2 percentage points less than the returns of the fund itself.

00:33:36.360 | And that's the problem with any fund that involves trading.

00:33:40.360 | So they were started for the right reasons, I think, and maybe I was just too dumb to

00:33:45.640 | realize that people wouldn't take my advice about how to use them.

00:33:48.680 | I am proud of my forecast, though, because I don't know how many people would have agreed

00:33:52.220 | with me that growth and value would do the same for 25 years, particularly 25 years ago

00:33:58.680 | when everybody thought value was going to do well forever.

00:34:02.640 | Rick, nothing does well forever.

00:34:06.160 | As you wrote in your book, it works until it doesn't.

00:34:09.520 | Exactly.

00:34:10.520 | The reality is, value, I mean, you see the data, you see the annual returns, value is

00:34:18.560 | unquestionably the leader.

00:34:20.240 | If you go back to the late 1920s is when these things began.

00:34:23.880 | But if you go back 25 years, they're the same.

00:34:28.680 | They come and go, and their returns over the last roughly 25 years are identical.

00:34:33.920 | So the value advantage did not persist, persisted for a long time, and in my opinion, the reason

00:34:42.400 | it didn't persist was everybody started to recognize it and act on it, which in theory

00:34:47.400 | at least means you bid up the price of value stocks and bid down the price of growth stocks,

00:34:53.520 | and then they perform the same.

00:34:55.640 | This is the market as a great arbitrageur between the past and the future.

00:35:00.600 | But we are all susceptible to making mistakes and sort of getting on the bandwagon.

00:35:05.800 | I'm going to go back to some earlier history.

00:35:10.520 | You were hired by Mr. Morgan after you graduated from Princeton, and you worked there and you

00:35:17.280 | became his heir apparent pretty much by the beginning of, by the mid-60s if you will.

00:35:25.960 | Actually, if I can correct you, Rick, in the mid-60s, that is to say in 1967, he called

00:35:34.080 | me into his office and said, "I want you to run the company from now on.

00:35:36.840 | I don't want to do it anymore, it's a crazy business."

00:35:41.520 | So that was a little more than his heir apparent, that was his heir.

00:35:46.480 | And you then said, "Well, this is the go-go era, if you will, and this is all in your

00:35:52.840 | book," and you've talked about it many times, how you made the decision that you needed

00:35:59.560 | to bring on a growth manager into the company.

00:36:04.960 | And that is what you did.

00:36:06.400 | You went out and you hunted down and looked for a growth manager who you ended up bringing

00:36:11.840 | on, partnered with, you know, it was a publicly traded company at that time, but they ended

00:36:17.560 | up having majority control.

00:36:19.840 | And that, as you said, worked for a while until it didn't, and that ultimately caused

00:36:26.400 | you to get fired, which started the restart.

00:36:31.400 | And you go into this in a lot of detail in the book, so I don't want to take too much

00:36:35.800 | time about it, but my point was that you learned the hard way that there's a cycle or a wave

00:36:44.600 | between growth and value, and it really cost you, at least at the time, it seemed like

00:36:49.800 | it was costing you, it almost cost you your entire career, because you got on the bandwagon.

00:36:55.280 | Let me just correct you ever so slightly.

00:36:58.400 | We had a balance fund, the most conservative balance fund, and since there was a few of

00:37:04.120 | them, we were often the industry leader in cash flow.

00:37:07.120 | It's amazing.

00:37:08.120 | The Wellington Fund was our only fund up until 1958.

00:37:12.960 | When the balance fund share of industry cash flow dropped from 40% to 1%, it doesn't make

00:37:19.840 | a genius to figure we better do something about that.

00:37:23.480 | And the original idea was to bring in or join forces with a firm that was strong in equities.

00:37:31.520 | So the firms I looked at were the firms you would recognize today.

00:37:36.560 | American funds would be the most obvious out of Los Angeles, the Capital Group.

00:37:46.120 | They were not interested.

00:37:47.440 | I talked to a fund called Incorporated Investors, a stand-alone pioneer from Boston stock fund,

00:37:55.200 | and they were not interested.

00:37:56.980 | I talked to a little tiny group of funds, mostly equity funds, in New York City who

00:38:02.560 | had I think it's $24 million worth of assets, tiny, tiny, in five funds or six funds, and

00:38:11.280 | they were not interested.

00:38:12.280 | Well, that was Franklin.

00:38:13.280 | Charlie Johnson said, "You know, I don't know if there's ever going to be a match to anything,

00:38:17.480 | but it's a family thing, and I think I'd just as soon stay independent and see what happens."

00:38:21.960 | He was smart.

00:38:23.540 | So finally I came up, the only thing I could do, which was okay in a way, was to bring

00:38:31.620 | in a company that had four professional managers, four professional investors, and turned out

00:38:38.960 | a go-go fund, which was called Ives Fund.

00:38:42.440 | So that was my best opportunity, but not my most desirable opportunity.

00:38:48.260 | I wanted to do something with a more middle-of-the-road fund, and if you can't do it, you do the second

00:38:53.380 | best, because we had to act.

00:38:54.940 | We were dying.

00:38:55.940 | We were going into an era where there were 83 consecutive months of redemption.

00:39:00.340 | Well, you brought them on, and that worked for a while.

00:39:03.820 | It seemed like you caught the second half of the go-go era, and things were going well

00:39:10.700 | for a while, although for Wellington, it still didn't stop the hemorrhaging of money because

00:39:14.980 | people just weren't interested in those funds anymore.

00:39:17.020 | I mean, the whole world was going go-go in a way.

00:39:20.940 | Well, let me come back to that.

00:39:24.540 | They said when the merger came along, my new partners, "We can't wait to get" -- I think

00:39:29.420 | this is in the book -- "can't wait to get our hands on a Wellington fund," and when

00:39:33.100 | they did, they ruined it.

00:39:36.260 | It had the worst 10-year record under their direction of any balanced fund in the industry,

00:39:41.340 | the worst.

00:39:42.340 | It's just hard to be last, Rick, in this world, it has to be first, so they ruined it because

00:39:47.420 | they turned it into go-go a fund, and the portfolio manager wouldn't listen to me when

00:39:52.700 | I told him it was too aggressive.

00:39:54.700 | It's all in the book.

00:39:56.980 | I made a mistake.

00:39:57.980 | There's no question about that, and maybe I should have looked for yet another merger

00:40:02.940 | partner.

00:40:03.940 | Well, we're all very glad you made that mistake, Jack, quite frankly, because what happened

00:40:08.740 | as a result of that was nothing less than absolutely phenomenal.

00:40:13.780 | When you eventually got fired by the Wellington board, you still retained your position as

00:40:21.780 | the fund chairman of the funds, and I want you to explain to the people who are listening

00:40:29.620 | the difference between being the CEO, the chairman of an asset manager who is making

00:40:37.300 | the investment decisions in funds and the fund itself.

00:40:41.260 | There's actually two different boards.

00:40:43.300 | You were fired from one, but you did not get fired from the other.

00:40:46.220 | Could you explain that?

00:40:47.220 | Yes, I can.

00:40:48.220 | First, the funds, the mutual funds, the mutual funds of the group, are pretty much no more

00:40:54.620 | than corporate shells.

00:40:56.460 | They hire a manager to do everything that they need to stay in existence.

00:41:00.700 | They hire an outside manager to manage the portfolio, an outside manager to do the financials

00:41:09.420 | and shareholder record-keeping, an outside manager to do the marketing and distribution.

00:41:15.020 | All the same firm, so the fund and the firm are pretty much wrapped up and bound together

00:41:21.620 | in the industry, and nothing like this had ever happened before.

00:41:26.300 | Generally speaking, when the manager, which is the controlling firm, fired, when the manager

00:41:32.200 | fired its president, the fund fired its.

00:41:37.980 | They were in lockstep.

00:41:39.980 | Why didn't that happen here?

00:41:42.460 | Because we still had directors from the old Wellington Management Company that I had run

00:41:46.100 | on the board, and they were barely a majority, and I tell that story in there, how close

00:41:50.940 | they came to being a non-majority, but they believed in me, and they didn't want me thrown

00:41:57.660 | out by these managers who had done, in fact, a terrible job, and why they kept them around

00:42:03.100 | to manage the money, I'll leave to wiser heads than mine.

00:42:06.300 | So, the fund, all of a sudden, became something, in effect, that had never become before.

00:42:13.000 | An operating firm, the chief executive who did something, who had no conflicts of interest,

00:42:19.440 | and a small staff, 28 for us, to do mostly accounting, because we couldn't do marketing,

00:42:24.880 | we were not allowed to get into marketing, we were not allowed to get into investment

00:42:28.160 | management.

00:42:29.160 | All we could do was administration and shareholder record keeping, which is essentially the third

00:42:34.660 | leg of the mutual fund stool.

00:42:37.100 | I knew, as I explain in the book, that we would get nowhere if we're just running this

00:42:42.660 | old skeleton of an administrative company.

00:42:45.760 | So, we had to take over investment management, and we had to take over marketing, both of

00:42:52.600 | which we were pledged not to do, but we did anyway.

00:42:56.320 | Well, it took a while, but you were able to convince the board, the other board members,

00:43:01.980 | in the fund itself, and the book is very detailed about how this happened, to allow you to take

00:43:09.520 | over, and one of the ways in which that occurred was through your idea, or your invention,

00:43:15.340 | if you will, of an index mutual fund.

00:43:19.560 | The very first one, by the way, there had been a few attempts, as you talk about in

00:43:23.760 | the book, of doing an index, S&P type index, investment pool in various places like Wells

00:43:31.460 | Fargo, but no one had attempted to do it within a mutual fund that was going to be available

00:43:36.400 | to the general public.

00:43:37.520 | So, you came up with the idea of doing that at Vanguard, and you said to the board, if

00:43:44.040 | I recall, "We're not managing, we're not picking the stock, so we're not the manager, so we're

00:43:50.560 | within the charter," and then you were able to convince them to allow you to start a S&P

00:43:58.440 | 500 fund.

00:43:59.440 | If I might jump ahead one point, you originally tried to sell this fund through the broker-dealer

00:44:05.120 | industry with a commission, true?

00:44:07.640 | That is true.

00:44:09.200 | Well, you have to get some money in the fund, and in those days, you didn't just put out

00:44:14.080 | a shingle and say, "Please send your money in," we put together an underwriting group,

00:44:19.880 | and they thought we could do $250 million, and they did 11.

00:44:24.200 | It was a complete failure.

00:44:25.920 | It was the worst underwriting probably in the history of Wall Street.

00:44:29.080 | So, how did they fail?

00:44:30.880 | I guess they failed because it was a really lousy idea, Rick.

00:44:34.280 | Well, no, if I recall, the commission that was being charged was lower than the commission

00:44:44.440 | of, say, selling an American fund.

00:44:48.520 | Wasn't the commission maybe 5% or 4% versus 8%?

00:44:51.920 | It was 5%, and in those days, the normal commission was 7.5% to 8%.

00:44:57.200 | So knowing the mentality of brokers, which I was one for 10 years, why on earth would

00:45:01.880 | I, as a broker, want to put my client's money in a fund that only pays me a 5% commission,

00:45:09.380 | in an untested product, by the way, when I could put my client's money in something like

00:45:14.520 | an American funds or some other fund that paid me 8.5%?

00:45:20.280 | And the fact that the actively managed funds do this payola.

00:45:26.840 | They do their brokerage trading with the firms that sell their shares, sometimes directly,

00:45:32.720 | sometimes what was called a give up in those days.

00:45:35.440 | You do the business with a firm like maybe Goldman Sachs, and they give up half of the

00:45:40.480 | commission to the firm that's selling to you.

00:45:43.160 | Don't ask me how that's legitimate, and it proved not to be legitimate eventually.

00:45:48.440 | But in any event, here's a fund that's not going to do any trading at all.

00:45:53.000 | And it was not a broker's product, but we had to get some money in at the beginning.

00:46:00.560 | And we tried and tried and tried.

00:46:02.440 | I don't know how many pairs of shoe leathers I wore out, trying to find first an underwriter

00:46:08.600 | and then trying to travel the country with these sales meetings and introduction meetings.

00:46:15.420 | And it all came to basically a failure.

00:46:18.600 | But we had the first index fund.

00:46:21.640 | And you also did manage to bring in, what was it, $11 million?

00:46:25.660 | I know you were trying to get about $150 million, but you did manage to get $11 million.

00:46:31.280 | And there's where the leap of faith occurred when you said to the board that you wanted

00:46:36.560 | to go ahead and launch the fund anyway, and they, in their wisdom, agreed to go ahead

00:46:41.440 | and do it.

00:46:42.440 | Yeah, there was no issue about that.

00:46:44.600 | The issue starting, we started, we formed the fund in September of 1975, which was only

00:46:52.520 | a few months, five months after we began operations in May '75, four months.

00:47:00.520 | And so we did it almost immediately.

00:47:03.000 | It was the first strategic thing we did at Vanguard.

00:47:06.080 | And we did it fast.

00:47:08.240 | The underwriting took place less than a year later, August of '76.

00:47:13.200 | It was, it's amazing what a struggle we had.

00:47:19.080 | And yet it's also amazing when you look at there, there's a lot of funny stuff going

00:47:23.280 | on out there about starting the first income account and this and that.

00:47:26.960 | And you look at all the people that did it, and there are five or six or seven or eight

00:47:30.920 | claimed to be first in indexing.

00:47:33.400 | None of them exist anymore.

00:47:35.800 | None of them exist anymore.

00:47:38.400 | And that one first index mutual fund is now one of the two largest funds in the world.

00:47:44.840 | So first or not, we're certainly first now.

00:47:48.920 | But when you took in the $11 million, there was a decision that needed to be made.

00:47:52.640 | So you did the underwriting.

00:47:54.200 | You wanted to bring in $150 million.

00:47:56.200 | It was a dismal failure.

00:47:57.200 | You only brought in about $11 or $11.5 million.

00:48:00.120 | How do you launch an S&P 500 fund with $11.5 million?

00:48:03.680 | You can't even buy all 500 stocks.

00:48:05.640 | So what did you do?

00:48:06.640 | Well, you can't buy all 500 stocks in round lots, and you don't want to buy non-round

00:48:12.480 | lots because it's too expensive.

00:48:14.120 | So we did a sampling.

00:48:16.120 | And I think the original portfolio was around 275 stocks.

00:48:20.900 | And if you sample by having a certain run amount in each industry, for example, you're

00:48:25.440 | going to come very close to the returns.

00:48:27.120 | I mean, first, stocks had a lot of commonality in their performance, stocks as a group.

00:48:31.880 | And when you get the industry, that's an even more greater commonality.

00:48:35.320 | In other words, if you have six airline stocks at 6% of the index, and you own only one of

00:48:41.480 | them, or maybe two, you're going to track that just as well as if you own all of them.

00:48:47.280 | And we did.

00:48:48.280 | The tracking was not as precise as we do today.

00:48:50.560 | Couldn't be.

00:48:51.560 | It was actually run by a part-time young woman who had her full-time job was in her husband's

00:48:58.520 | furniture store in Wilmington, Delaware.

00:49:00.920 | But she did fine.

00:49:01.920 | It wasn't sophisticated like it is today.

00:49:05.320 | That was your portfolio manager.

00:49:06.720 | It was a woman who worked for you who, it was a part-time job.

00:49:10.520 | She was managing the first S&P 500 Index Fund portfolio part-time while she also worked

00:49:15.680 | in her husband's furniture shop full-time.

00:49:17.520 | Right.

00:49:18.520 | Yeah, it's amazing.

00:49:19.520 | It's just unbelievable.

00:49:20.520 | Well, I'm going to skip ahead a little bit because it is-

00:49:26.520 | Yeah, because I'm often found to say, "You can't make this stuff up."

00:49:32.120 | I'm going to move ahead a little bit because I know we've spent some time, considerable

00:49:38.400 | time so far, and this could go on for a long time because I started printing out all the

00:49:44.440 | things I wanted to talk about from your book and I ended up, I got 50 pages printed and

00:49:48.640 | I just stopped because there's so much stuff to talk about.

00:49:51.580 | But there's one thing I do want to talk about.

00:49:52.880 | When you turned the S&P 500 fund from a load fund where it was sold through brokers into

00:49:58.600 | a no-load, and that was a new concept, and you also merged one of the Wellington funds

00:50:04.620 | into the S&P 500, and that gave you enough money to finally buy all 500 stocks, and you

00:50:10.920 | were no-load, and you at that time, you got permission to do your own marketing, so now

00:50:15.120 | you were a full-fledged, Vanguard became a full-fledged company with all three legs.

00:50:19.920 | I mean, you were able to do the administration, you were able to do the marketing, and you

00:50:24.200 | were able to do the management.

00:50:26.520 | We were ready to compete in the full line mutual fund field, and stand back everybody,

00:50:31.880 | here comes Vanguard.

00:50:32.880 | And here you came, but very, very slowly because if I recall, it took you something like 10

00:50:39.080 | or 11 or 12 years for the Vanguard S&P 500 fund to actually get its first billion dollars.

00:50:45.160 | It wasn't like it just, it didn't explode.

00:50:48.400 | It was so slow, it was awful, and yet you had to keep running the company as if it would

00:50:57.880 | come sooner or later, and it did, and we started in 1974 with a billion five, by 1990, we were

00:51:05.960 | at 55 billion, but less than 10% of our assets were in index funds, less than five billion.

00:51:15.200 | Then the boom comes, we're now 78% of our assets in index funds, even in the 2000s,

00:51:22.320 | 2010, we were 60%, so the momentum of indexing and the Vanguard way, the mutuality, and they

00:51:30.880 | go together, by the way, Rick, if you're not mutual, you really don't want to be in the

00:51:36.760 | index business.

00:51:37.760 | As I've often said, all the damn money goes to the clients, and managers don't like that.

00:51:43.480 | They want all the money to go to them, and they compromise and give half of the money

00:51:47.200 | to the clients.

00:51:48.200 | That's a little hyperbole.

00:51:50.200 | I wanted to talk about a story where you went to the SEC and you asked them, you submitted

00:51:55.320 | a filing to do the first bond index fund, and you got a lot of pushback on that, where

00:52:01.400 | they said, "No, you can't call it an index fund because you're not buying all of the

00:52:05.240 | bonds in the index," so you had to call it something else originally.

00:52:08.560 | An interesting sidelight is when we work with the SEC, I travel alone, no lawyers, no retinue,

00:52:19.520 | and nobody at my side to tell me what to do, and nobody to consult with.

00:52:24.080 | I'm confident to do it myself, and I think it looks better to the SEC.

00:52:28.000 | They always have a room full of people, and they wonder who this funny non-lawyer is,

00:52:32.440 | so we get down to present this, and they are hardly expert on the name.

00:52:39.720 | They wanted to talk about the name, and they said, "Look, we're just not going to let you

00:52:42.960 | call it Vanguard Bond Index Fund," and I said, "Okay, we'll call it Vanguard Bond Market

00:52:51.000 | Fund."

00:52:52.000 | They said, "That's fine," and then I said, "But we'll refer to it as the Vanguard Bond

00:52:56.640 | Market Index Fund."

00:52:58.880 | They said, "That's fine, just as long as you don't put it in the name," so it was fun to

00:53:03.280 | do.

00:53:04.280 | What I didn't realize when I was reading your book was that Vanguard manages something like

00:53:10.320 | 25% now of all fixed income assets in mutual funds.

00:53:17.560 | It's a phenomenal amount of money that Vanguard manages in bonds, most of which are in bond

00:53:23.680 | index funds, so this has been an incredible growth area.

00:53:28.120 | Once you finally got it...

00:53:29.120 | Yeah, but we also manage about 25% of all the money in equity funds.

00:53:34.920 | Our total market share is 25%, and bonds are actually a little below that, and stocks are

00:53:41.600 | a little bit higher than that.

00:53:43.280 | I'm going to go back to active management, though, because I found something in your

00:53:46.120 | book which I found very interesting.

00:53:47.440 | I hadn't read it before, but you put in your book what you call Vanguard's four P's in

00:53:54.440 | evaluating fund managers, and you're talking about active managers, because Vanguard traditionally,

00:54:01.980 | like you said, until 1990, 95% of the assets into Vanguard were actively managed, so you

00:54:07.320 | had to create some sort of a system or methodology for choosing the active managers who you were

00:54:16.000 | going to hire to manage the funds that you had, like the prime cap and such.

00:54:23.680 | What I read in your book, which is the first place I think I've read it before, was you

00:54:27.440 | actually had laid out here a system that you used for determining which active managers

00:54:34.320 | that you were going to hire.

00:54:35.840 | Yeah, it was actually less of a system, and maybe a series of checkpoints.

00:54:41.840 | I don't mean to belabor that, but it wasn't as if we did ratings all up and down those

00:54:47.160 | numbers and gave managers scores from 1 to 10.

00:54:52.120 | We looked at the way they made the basic performance standard, performance being the last thing

00:54:58.320 | we looked at, but we looked at philosophy, we looked at people.

00:55:03.420 | Without those kind of things, we looked at the portfolio to make sure it carried them

00:55:07.000 | out, and then finally, we looked at the performance.

00:55:11.480 | Performance is so deceptive because it doesn't repeat, and it's cost investors I'm sure hundreds

00:55:18.560 | of billions of dollars who just jumping back and forth from a fund because they think they

00:55:23.120 | buy it for the performance, and then they don't get the performance, so they sell it.

00:55:29.760 | There's no better example, and I don't mean to be catty, than Magellan Fund, who did very

00:55:35.140 | well for quite a number of years and got to be at $110 billion and had never done well

00:55:41.200 | since and is now about $11 billion in assets.

00:55:44.480 | It's a loss of $100 billion.

00:55:49.160 | Investors have withdrawn or the market has taken away.

00:55:52.600 | >> In 1996, when you turned over CEO, what percentage of the assets at Vanguard were

00:55:59.740 | index funds and what percentage was active?

00:56:02.660 | Do you recall?

00:56:03.660 | >> Sure.

00:56:04.660 | We were 31% index.

00:56:05.660 | >> Oh, okay.

00:56:06.660 | So, you had really jumped even over a five-year period of time, say 1991 to 1996.

00:56:14.340 | >> Yeah.

00:56:15.340 | I have a little bit in the book about momentum, and that index momentum, you know, we went

00:56:21.860 | from, let's say, 10% in 1990, so let's say 7% in 1989 to 50% in 1999, so the growth rate

00:56:33.260 | has really slowed down, believe it or not, to 75%, 78% in 2018.

00:56:39.620 | In other words, it went up five times, I guess that's right, and after that, it's going up

00:56:47.900 | about 50%.

00:56:48.900 | >> By 1996, all the pieces were in place for the huge growth of indexing and traditional

00:56:57.740 | index funds, and that has been the area that has really taken off at Vanguard, and most

00:57:03.740 | of the assets have gone into those traditional index funds that you created in 1996 or prior,

00:57:09.780 | or they were on the board at least by 1996, and that really is what Vanguard indexing

00:57:15.980 | is about, is those core funds, the ones that you had created.

00:57:20.800 | But for the last 22 years, you've been very influential in the industry and very much

00:57:26.740 | a part of the industry and educating investors, and not only educating investors, but also

00:57:32.220 | trying to educate the industry and educate regulators on where the industry needs to

00:57:38.020 | go.

00:57:39.700 | And part three of your book is all about the future of investment management, where you

00:57:44.880 | look at where we are now and give your views, basically three ideas, of where the company

00:57:54.260 | is going or should go in the future.

00:57:57.380 | And the very first one that you talk about is the mutualization of major firms.

00:58:03.900 | And what I read about this is that you believe that other major mutual fund companies eventually

00:58:11.380 | must mutualize, like Vanguard started out doing, if they're going to survive.

00:58:17.380 | Can you elaborate on that?

00:58:18.380 | Well, it's pretty easy to elaborate on, and that is the difference between a mutual

00:58:23.380 | company and a traditional company outside external manager is that the mutual company

00:58:31.100 | basically gives all those huge management company profits that they would otherwise

00:58:35.220 | earn back to the shareholders, and the external manager does not.

00:58:39.740 | This is a particular problem when the external manager is a subsidiary of a big conglomerate,

00:58:45.940 | because the big conglomerate buys the mutual company, this is the way corporations work.

00:58:51.180 | They buy the mutual company and they want a 15% return or a 20% return on their capital,

00:58:56.180 | and if they don't get it, they will hire somebody who will get it.

00:59:00.860 | That's the business, to make money by getting into it on the ground floor of an industry.

00:59:06.700 | So in my book I think I point out that of the 50 largest mutual fund companies, 40 of

00:59:14.300 | them, maybe 41, are externally managed by financial conglomerates.

00:59:22.060 | They're publicly held, I'm sorry I misstated that, they're publicly held about half by

00:59:27.580 | financial conglomerates and half by public investors, and those investors want money.

00:59:34.900 | They want growth.

00:59:36.380 | They want dividends.

00:59:37.380 | These are the shareholders of the management company, so it's a direct conflict of interest,

00:59:42.780 | and that is the one major reason why mutual funds don't outperform the market indexes.

00:59:49.820 | There are a whole lot of other reasons, but that comes right in there.

00:59:53.700 | So how are you going to get your fees, I mean if you got your fees so low that you made

00:59:59.780 | no money, I don't know what your owner would say.

01:00:04.620 | So they can't compete on cost, and people have started to realize that cost is almost

01:00:10.340 | everything.

01:00:12.220 | Cost comes and goes.

01:00:14.300 | Costs go on forever, and if people accompany their interest in cost, we're seeing what

01:00:21.340 | a tremendous burden it is over the long term, and I think I have data in the book that shows

01:00:28.580 | that if the market yields 7%, you end up over 25 years, I guess, with $30 for each dollar

01:00:37.420 | invested initially, then maybe 50 years, let's say 50 years, $30 for a dollar, and if you

01:00:43.980 | get 5%, a dollar grows to $10.

01:00:48.300 | That means 2/3 of your long term return has been consumed by cost.

01:00:54.900 | It makes no sense, and as people get aware of that, they're going to have to get their

01:01:01.180 | cost down, as their clients get aware of it, and when the clients wake up, the industry

01:01:07.180 | will wake up.

01:01:08.180 | I see somewhere in your book, you wrote, you came up with the number of how much money

01:01:12.260 | Vanguard has saved investors, and it was somewhere in the order of $217 billion is what you estimated

01:01:19.540 | Vanguard has saved investors because of the continued pressure of pushing down fees.

01:01:25.580 | So you have a lot of data in there about that, and there was one thing, too, I want to point

01:01:29.100 | out about what you just said about the cost, is that it's always been my belief that costs

01:01:35.140 | matter, that's been your mantra, costs matter.

01:01:37.940 | You're taking my motto.

01:01:39.460 | No, that's your motto, that's what I'm saying, it's not mine, it's yours.

01:01:42.780 | Costs matter.

01:01:43.780 | The reason why index funds outperform most active management, the bottom line is cost.

01:01:50.100 | It's not because we have dumb managers out there, because in aggregate, all the managers

01:01:55.260 | put together are the market, so we're just talking about cost, correct?

01:02:01.060 | For cost, the average manager is average.

01:02:04.220 | I'm talking about if the market's total return is 7%, all the investors in the market earn

01:02:09.460 | gross 7%.

01:02:10.780 | Now this is not nuclear science, this is not brain surgery, this is the relentless rules

01:02:19.420 | of humble arithmetic.

01:02:21.780 | As William Sharpe said, your last argument is about the antiquated laws, the legislation

01:02:30.740 | that we have from the Investment Company Act of 1940.

01:02:35.440 | You say that there needs to be a complete rewrite of the Investment Company Act, which

01:02:40.340 | is the law that governs mutual fund companies and investment companies, and you talk about

01:02:47.140 | the Financial Institutions Act of 2030 to replace the Investment Company Act of 1940.

01:02:57.180 | You make the argument that that Act of 1940 existed when there was only a few companies

01:03:01.780 | around and they all looked a lot like Wellington, if you will, with one fund, and it spent too

01:03:07.560 | many patches and the whole thing needs to be redone.

01:03:10.900 | Well that's right.

01:03:12.100 | It was also, if you read the Act with Care, which I did a long, long, long time ago, the

01:03:19.300 | reality is it was written mainly to curb the abuses of closed-end companies, which sprang

01:03:26.300 | up in the late 1920s and vanished in the 1930s.

01:03:31.140 | So it was a closed-end company act by and large.

01:03:34.620 | It also regulates funds.

01:03:38.140 | Each fund, no fund, for example, can own more than 10% of the voting stock of any security.

01:03:45.320 | Where today we don't have a mutual fund industry as such, we have a mutual fund complex industry.

01:03:50.740 | So if each fund can only have 10%, does that mean if you have 20 funds you can have 200%?

01:03:55.900 | I don't think so.

01:03:58.780 | One of the areas that to me has really helped propel your message and your vision has been

01:04:04.980 | social media.

01:04:07.180 | The Bogleheads, for example, which was originally established on the Morningstar Forum and then

01:04:14.380 | we moved off to a separate independent website called bogleheads.org, has done, I think,

01:04:22.220 | just a tremendous job of helping to spread your message and low fees, fees matter, and

01:04:30.500 | all of the good investment ideas that you have been putting out there for many, many,

01:04:35.340 | many years.

01:04:36.340 | I see social media as helping to really expand the knowledge of the individual investor out

01:04:44.340 | there and really has helped people to understand and embrace the concept, to have that epiphany

01:04:50.080 | or that aha moment about why index funds work.

01:04:54.100 | You've never really talked about getting the word out and I haven't read anywhere where

01:04:58.700 | you've really gotten to your comments about social media and how it might have helped

01:05:03.740 | you and helped Vanguard grow.

01:05:05.920 | Can you comment on that?

01:05:07.900 | Sure.

01:05:08.940 | I have not written a lot about social media generally, but I have written including a

01:05:13.260 | couple of forwards about a particular social media called the Bogleheads and they have

01:05:18.540 | been an enormous asset to Vanguard, a staggeringly large asset and not only do they get heard

01:05:26.260 | when they have a complaint and a complaint from them is as good as gold.

01:05:32.340 | If we get a complaint from someone that we know, it turns out we'll see how many people

01:05:37.060 | are affected by it, how many shareholders, and fix it.

01:05:40.880 | You want people who criticize you up to a point and the Bogleheads have not only helped

01:05:45.620 | one another, as everybody knows, I mean it's been a fantastic website with participation

01:05:52.260 | that's beyond belief, I think by far the most popular financial website that's out there,

01:05:58.940 | but it's independent, it has nothing to do with us, they have nothing to sell, but good

01:06:04.580 | grace and good advice.

01:06:06.900 | So the Bogleheads stand alone in being a huge asset to Vanguard and a huge asset to indexing.

01:06:15.180 | I should add without taking anything away from the Bogleheads at all, another great

01:06:19.700 | source of our strength is academia, few business school courses in investment do not talk the

01:06:27.820 | index as book, if you will, the Bogle message, it's academic community, Andy Lowe at MIT,

01:06:36.540 | Bill Sharpe, Bert Malkiel at Princeton, they're all there and he's not quite an academic,

01:06:44.780 | but David Swenson at Yale, the money managers of the colleges which are very much indexing,

01:06:53.300 | so it's not just the man on the street, if you will, or woman on the street, the Bogleheads

01:06:58.660 | worthy of help and worthy of honor, but it's the man off the street in the ivory tower

01:07:06.180 | of education, financial education and sophisticated concepts that have also been a great asset.

01:07:17.940 | Rest assured that the Bogleheads will ensure that you have a legacy.

01:07:22.440 | With that, we thank you very, very much for everything that you've done for the industry,

01:07:28.500 | everything you've done for millions of investors in the U.S. and internationally, and your

01:07:34.980 | work will go on for many, many years after all of us are gone.

01:07:40.340 | So thank you for this interview, we greatly appreciate it.

01:07:44.380 | Thank you, Rick.

01:07:45.380 | Good to talk to you, and good luck to the Bogleheads.

01:07:50.980 | This concludes the first episode of Bogleheads on Investing.

01:07:55.380 | Join us each month as we have a new special guest.

01:07:58.220 | In the meantime, visit Bogleheads.org and Bogleheads Wiki, participate in the forum,

01:08:06.180 | and help others find the forum.

01:08:08.380 | Thank you for listening and have a great week.

01:08:13.180 | [Music]

01:08:20.180 | (upbeat music)

Bogleheads® on Investing Podcast 001 – John C. Bogle, host Rick Ferri (audio only)

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