Bogleheads® Conference 2016 - John Bogle Keynote

00:00:00.000 | Okay, at this time, I'd like to introduce our distinguished guest of honor.

00:00:06.040 | He's the founder of Vanguard and president of Vanguard's Bogle's Financial Research Markets

00:00:12.440 | Research Center.

00:00:14.240 | He created Vanguard in 1974 and served as chairman and chief executive officer until

00:00:19.280 | 1996 and senior chairman until 2000.

00:00:24.180 | He entered the investment field immediately following his graduation from Princeton University,

00:00:29.160 | Nyingekomlata, with a degree in economics in 1951.

00:00:34.140 | If I listed all of his honors and achievements, which most of you already know, we wouldn't

00:00:39.260 | have any time to listen to Jack.

00:00:42.180 | So I'll dispense with that and ask you to please welcome our special guest of honor,

00:00:46.240 | Mr. Jack Bogle.

00:00:50.700 | We normally...

00:00:51.700 | I'm going to steal a couple of minutes from Jack's speech for something that's very important.

00:00:56.760 | We normally do our recognition ceremony at the end of the event on the last day, but

00:01:04.380 | we've got something very special to do this time, and I think it deserves its own time

00:01:08.540 | on the agenda.

00:01:10.820 | The person we're going to honor today is a very special individual.

00:01:14.860 | I've had the pleasure of working with him for the past 18 years.

00:01:19.180 | We've worked together, helping to build one of the old Vanguard diehards form into the

00:01:23.860 | number one form on Morningstar, and then later building the Bogleheads form into the number

00:01:30.860 | one investing form on the internet.

00:01:34.360 | We worked together to host the first Bogleheads conference with Jack in Miami.

00:01:38.940 | We worked together writing the Bogleheads books.

00:01:41.980 | We've raced together in the weekly Biscayne Bay regatta.

00:01:45.660 | We celebrated birthdays together, and we spent weeks cruising together.

00:01:51.080 | So to say I know this person is really an understatement.

00:01:55.940 | He's an ace through and through, and a real gentleman.

00:01:59.700 | Since he no longer cares to travel, this is, for all practical purposes, his last conference.

00:02:06.060 | So I thought it only proper that we acknowledge the great contributions he's made in the establishment

00:02:11.060 | and continued growth of the Bogleheads community.

00:02:15.100 | Jack calls him the king of the Bogleheads.

00:02:17.220 | I call him my very dear friend.

00:02:19.620 | Would you all please give a rousing round of applause to Taylor Laramore.

00:02:24.660 | Will you please come up and accept this award, Taylor?

00:02:33.880 | I'll read the award.

00:02:49.040 | It says the John C. Bogle Center for Financial Literacy Lifetime Achievement Award presented

00:02:54.520 | to Taylor Laramore for his service in World War II, his exemplary government career, his

00:03:01.240 | leadership in founding and building the Bogleheads community, a lifetime of being a kind, decent,

00:03:06.760 | and helpful human being.

00:03:08.920 | Presented at the Bogleheads 2016 conference, Philadelphia, PA, signed John C. Bogle Honorary

00:03:15.040 | Chairman and Melinda President.

00:03:35.280 | Everything I know I learned from Jack Bogle.

00:03:39.560 | Don't move quite as fast as I used to.

00:04:02.720 | Sorry about that.

00:04:06.240 | It reminds me a little bit of last year.

00:04:10.880 | I have the same awesome vision here, a room filled with wonderful guys and gals who are

00:04:20.560 | here as Bogleheads.

00:04:23.000 | Whoever would have thought that?

00:04:24.800 | Whoever would have dreamed that 15 years ago?

00:04:27.520 | There's only one person, of course, and that's Taylor Laramore, my dear friend.

00:04:33.600 | Here we are this morning with two founders, the founder of Vanguard and the founder of

00:04:40.880 | the Bogleheads.

00:04:41.880 | I'm always proud to be in his company.

00:04:45.120 | I really love the guy and wish he and Taffy, his companion, the very best.

00:04:50.840 | They're a lovely, lovely couple and still taking all the flags and birgies at the regattas

00:04:58.560 | down in Florida.

00:05:03.200 | I'm barely on a boat without a crane, but I try.

00:05:09.080 | Welcome to all of you and thank you for coming.

00:05:12.160 | Congratulations to the Bogleheads, Mel and all the rest of you, for I think it's three

00:05:19.800 | million posts?

00:05:23.720 | Over three million.

00:05:24.720 | I'm always given the understatement.

00:05:26.000 | You all know that.

00:05:29.000 | What did I see?

00:05:31.080 | No?

00:05:32.080 | 35,000 members?

00:05:33.080 | How many members?

00:05:34.080 | I'm underestimating again.

00:05:35.080 | I want to give special thanks at the beginning to Mike Nolan, starting his sixth year in

00:05:45.040 | penal servitude, who has been a fantastic help to me.

00:05:53.000 | We work together on just about every project.

00:05:55.960 | He travels with me, partly because I think he enjoys being in the venues that I'm speaking

00:06:01.360 | at and working at.

00:06:05.160 | For that asset, he has a liability of traveling with me.

00:06:11.800 | Getting me through Union Station in Washington is not easy, but when we get there, we always

00:06:18.160 | call an Uber, so Uber has made our lives worthwhile.

00:06:31.000 | I'll mention at the same time, you couldn't do anything without you, Mike, and I appreciate

00:06:34.120 | your friendship, your loyalty, your commitment.

00:06:38.440 | He's a tremendous hard worker.

00:06:39.720 | He probably got to the office at what, 6.15 this morning?

00:06:44.400 | 5.50.

00:06:45.400 | 5.50.

00:06:46.400 | I wondered how he beat me.

00:06:50.120 | That's not what it takes anymore, and I'm working as hard as I used to.

00:06:55.560 | I also want to now thank, I'll thank her publicly later on, Emily Snyder.

00:06:59.880 | Mike is starting his sixth year here with me.

00:07:04.160 | Emily is starting her 26th year with me, and don't ask, don't ask, and I won't tell

00:07:12.760 | how she puts up, but I don't know, but she is a lovely woman, young woman really, gracious

00:07:19.360 | with everybody she comes in contact with, a prodigious worker, loyal to a fault, and

00:07:26.080 | I don't know what I'd do without her either, and that's it for the Bogle Financial Markets

00:07:29.760 | Research Center.

00:07:31.120 | People think that there's 40 people down there creating and cranking out all this work that

00:07:36.560 | I do, or that we do, that I publish, but we do, and no, there are only the little three

00:07:42.600 | of us fighting our way through each day, which is, in truth, not quite as easy as it used

00:07:50.560 | to be.

00:07:51.560 | I still enjoy it, but I tire a little bit.

00:07:56.280 | I suppose that's fair enough for someone who is celebrating 65 years, essentially with

00:08:02.120 | the same company I've been involved with, Wellington Fund, leave aside the names of

00:08:05.640 | the management companies, ever since 1951, talk a little bit about that later on, 60th

00:08:12.720 | anniversary in the industry, the 40th anniversary to celebrate this year, first index investment

00:08:19.600 | trust, somebody actually bought shares in first index funds when I was here today, and

00:08:24.640 | that's now the S&P 500 been renamed.

00:08:27.360 | We were proud to have that first stamped on our name, a time when everybody thought it

00:08:31.800 | was well stamped, everybody thought index funds should be stamped out, and you saw that

00:08:38.640 | poster, I think, and some of the things that I've done, and best of all, as if 65 and 40

00:08:46.140 | aren't enough, you're not going to believe this, because I'm a very difficult character,

00:08:52.260 | my 60th wedding anniversary, and Malthus being Malthus, our family now is 31, and counting

00:09:07.780 | in-laws, I don't know, a little difficult when gift tax times come along, and I also

00:09:16.740 | want to say something important, I'm not going to join you for the reception this afternoon,

00:09:24.980 | but that's mainly because my wife wants me home a little bit earlier, because I don't

00:09:29.820 | want to be, you know, as if I'm spying on people, I've been asked three or four times

00:09:34.860 | to come, invited, no question about that, and it's going to be run by, the moderator

00:09:41.460 | is going to be one of our bright, up-and-coming young managing directors named Chris McIsaac,

00:09:46.860 | who's become a good friend of mine over time, and I'm really a great admirer of Chris's,

00:09:52.500 | and you'll see him in action, and Mike will report to me whether he does a good job or

00:09:57.700 | not, and I don't think I won't be watching, and I also want to say one of the best things

00:10:03.140 | that's happened this year, I want to try and say this tactfully, is that we've come together,

00:10:09.980 | the Vanguard management, present management, and I have come together, and we have kind

00:10:14.940 | of mutual harmony, all the arguments have been settled and put aside, and so it's the

00:10:22.980 | best relationship I've had with Vanguard, which has been, as everybody knows, I think,

00:10:26.940 | a bit rocky along the way, to say the least, and so that's another highlight.

00:10:33.660 | So this has been a good year for me, and I'm happy to be with you to talk a little bit

00:10:38.260 | about that.

00:10:39.940 | It's been a year when, oh wait, I've got that up there, when I got a couple of nice headlines,

00:10:46.900 | I want to flip that slide, right, to that article in the Wall Street Journal, which

00:10:54.140 | I must say, it just couldn't have been nicer in every way.

00:10:59.020 | I don't know where the hair went in front of my head, I know it on the lot, but I've

00:11:04.180 | got more than that!

00:11:08.340 | But Holman liked it, Holman Shangothy, author, I guess, gets approval rights, I don't know

00:11:12.580 | where he got that ghastly sweater and jacket, but I have been known to wear a tweed anyway,

00:11:17.640 | so it's a good try.

00:11:18.640 | It was really nice.

00:11:21.020 | One of the non-highlights, I don't know where this comes from, but people comment on these

00:11:26.240 | articles in the press now, and this one got, I think, around 220 comments, and too many

00:11:35.080 | of them, maybe as many as 15 or 20, really did not like the article.

00:11:42.640 | How could you ever vote for Hillary?

00:11:50.360 | And one of them was a little biting, and said, "If you're that dumb, I'm glad you're not

00:11:54.840 | running Vanguard anymore.

00:11:58.160 | It goes with the territory!"

00:12:01.240 | And just to be honest, I don't like answering political questions with that kind of question,

00:12:06.640 | but I build name and reputation for integrity and candor, and I'm not about to say I'm not

00:12:12.040 | going to answer your question, which is not my style, it gets me in trouble a lot, but

00:12:16.880 | I think the payoff is getting the respect of people for speaking as honestly as I can.

00:12:23.680 | Who else is interviewing me or talking to me?

00:12:26.240 | So that was a nice one.

00:12:28.080 | And then there was this business of indexing is worse than Marxism.

00:12:37.160 | And it was quite a diatribe, only about 40 pages, and published by Sanford Bernstein

00:12:47.000 | Company, a big investment advisor and broker, and they can't stand indexing.

00:12:52.600 | So they got somebody to write an article, one of their staff, who said it was going

00:12:55.760 | to ruin the world.

00:12:56.760 | It seems to me it's more likely to save the world, but that's another story.

00:13:01.760 | But my good friend Cliff Asness, the head of AQR, a huge hedge fund manager, they probably

00:13:08.240 | run, I don't know, $80 billion, and he wrote a rebuttal to the article in Bloomberg where

00:13:18.160 | the article first appeared, and he said indexing is capitalism at best.

00:13:24.120 | He got it.

00:13:25.640 | And I take some pride in having friends in the hedge fund business, and if they're doing

00:13:30.680 | a good job and have the right posture and integrity and all that, I have no problem

00:13:35.640 | admiring them.

00:13:36.640 | Well, Cliff describes himself as Jack Bogle's least hated hedge fund manager.

00:13:45.600 | I think my son would be in that category, too.

00:13:52.680 | So it says at the bottom, all that glitters is not gold, but it is gold.

00:13:57.800 | And I just thought I'd mention a little bit, I don't know, bragging, a couple of gold medals,

00:14:03.960 | one that I got and one that I will receive.

00:14:06.480 | You heard about the first one, the Gold Medal for Distinguished Service to Society, which

00:14:11.080 | is pretty big, and the Pennsylvania has a big party in New York every December for about

00:14:18.200 | 110 years, 115, I think it is, and the first award winner was Andrew Carnegie, who's older

00:14:25.360 | than I am, if you can believe that, and getting these awards basically for telling the truth,

00:14:31.240 | spreading the word, and that I do.

00:14:34.800 | No question about that.

00:14:37.560 | It's all about simple stuff, common-sense investing, in the title of two of my books,

00:14:44.160 | sound investment principles, investment costs and returns, trust, and the role of integrity,

00:14:52.560 | which has come into sharp relief with that really bad piece of work done by Wells Fargo.

00:14:59.640 | The bank probably had the best reputation, had the best reputation of any bank in the

00:15:07.000 | country.

00:15:08.000 | And so that can happen to anybody, any time, and I spent a lot of my time here in the incipient

00:15:14.280 | years, the early years, trying to make sure I touched every base.

00:15:17.480 | You know, I could be around, we started Vanguard with 28 people, that's about that table and

00:15:24.120 | that table and that table, and maybe one more.

00:15:28.160 | And so I was on top of everything, all of the details, I loved the details of the business.

00:15:32.400 | And I was watching, I was listening, to make sure that very kind of thing, we didn't have

00:15:37.120 | any incentives for selling more, people on the phones don't get paid if you send us money,

00:15:42.600 | I can't imagine anything more idiotic, anything that was more cutting to your integrity.

00:15:48.280 | So I've put in 60 years, 65 years, and how many hits have I had and how many errors have

00:15:56.280 | I been through, just about all of them.

00:15:58.840 | And as you saw this chart last year, I've seen this go from an industry that sells what

00:16:04.080 | it makes to an industry that makes what it sells.

00:16:06.560 | I won't spend a lot of time on this list, you can see them up there, but all these different

00:16:12.240 | things we've fought through.

00:16:14.440 | And starting Vanguard in the middle of all this, you couldn't possibly, possibly think

00:16:20.920 | of a company that had a poorer chance of surviving.

00:16:25.840 | It's a company with a new name, an industry that is back on its heels, and its predecessor,

00:16:31.200 | Wellington Management Company, was among the leaders in companies that were back on their

00:16:35.520 | heels.

00:16:36.520 | Redemption's pouring into the industry, more to us, market share plummeting, we were obliged

00:16:43.520 | to keep the same managers that ruined the funds in the first place, under the deal with

00:16:47.800 | the directors that led us to form Vanguard.

00:16:52.200 | And the outlook is grim, mutual funds, the industry dropped its assets by a third, we

00:16:59.000 | dropped by even more than the previous company.

00:17:04.240 | And then you got a new idea, it's called the Index Fund, never tried it before.

00:17:08.480 | What chance does a company like that, with its new structure, we call it the Vanguard

00:17:12.040 | Experiment, no one ever run a mutual fund that was mutual before.

00:17:16.800 | So what are the chances that company will succeed?

00:17:19.220 | I don't know, I'd say one in a thousand.

00:17:21.740 | If you pushed me into a corner, I'd say one in a million.

00:17:24.560 | But here we are today, well, I'll get to the size of the industry now, but I've done my

00:17:31.400 | best all this period, I say in my note here, did my best to build a better industry, but

00:17:38.420 | I think a better phrase was, I did my best to disrupt an industry that was sadly in need

00:17:45.720 | of disruption, and that is happening, as you'll see from these slides.

00:17:49.960 | When I preach about my convictions, the preacher, Ecclesiastes, it all begins with, and I love

00:18:00.800 | this quote from the musical Hamilton, I don't know if any of you have seen it, we have seen

00:18:09.140 | it, Lynn Miranda was actually in it, we felt very happy about that, but with the introducers

00:18:14.740 | you can see this on the video, you can go to one of the video sources and find it very

00:18:22.980 | easily, Lynn Miranda, Hamilton, White House, just put that in and you'll see it.

00:18:27.920 | And he says in this thing, talking about Hamilton, all in the strength of his writing, he embodies

00:18:33.900 | the words, ability to make a difference, and I've done my best to emulate that.

00:18:39.220 | I am no Hamilton, no question about that, but I've tried to emulate that all through

00:18:43.900 | my career, and I'll get to the preaching in a minute, but we've started to get much more

00:18:50.980 | recognition for how much our structure and our strategy, mutual structure and the index

00:18:56.380 | strategy has saved our investors, and Bloomberg came out with an article, it puts that number

00:19:03.900 | at $1 trillion.

00:19:06.140 | Now it should have said "is saving" rather than "has saved" because they looked ahead

00:19:12.380 | for five years as well, and it should have also said they were wrong there, and if you

00:19:19.100 | do the math using their formula, it's actually $2 trillion.

00:19:27.140 | And here's the data, and the first three boxes are just what they do.

00:19:36.300 | They talk about lower expense ratios, lower trading costs, the effect on our competitors.

00:19:45.780 | Where are we here, $200 billion, and the future savings we'll get doing that, I'm projecting

00:19:51.620 | over the next years, the original savings come right out of the Vanguard calculation,

00:19:56.380 | which is what our principal competitors charge minus what we charge, and multiply that number,

00:20:05.700 | expense ratio number, it's probably about 70 basis points or something, 60, times a

00:20:12.140 | trillion dollars, and you're talking real money, and so it's right there, and it's made

00:20:19.340 | us into the nation's second most important company, according to Fortune, and there they

00:20:27.780 | are.

00:20:28.780 | They said, Fortune said, it was a tie with Fidelity.

00:20:36.380 | Are you kidding?

00:20:37.980 | I mean, Fidelity is yesterday, pal, and as I said in that Wall Street Journal story,

00:20:47.020 | which I probably should not have said, they'll probably sell the company within the next

00:20:52.860 | five years.

00:20:53.860 | You know, I don't think that was a smart thing to say, but I believed it, and so we're tied

00:20:59.620 | with Fidelity, they say, even though they're limping badly, and I feel kind of badly.

00:21:05.020 | They just built a company on flashy performance, and then it was over, and they've struggled

00:21:12.020 | to keep up all the time, and they fail, and I don't wish them ill, I wish them well.

00:21:19.020 | My good wishes don't seem to have, they seem to have fallen on deaf ears up there, but

00:21:23.260 | I do wish them well, and you're probably saying, who's the most, this is the most important

00:21:30.820 | private companies, which has something to do with, well, Fortune doesn't quite say it,

00:21:36.860 | the most valuable private companies, and it's quite remarkable, because people have forgotten

00:21:43.980 | that we have shareholders, and they have a value, and the Johnson money goes to the Johnson

00:21:50.380 | family, and our value goes to our shareholders, and I don't think anyone's ever looked at

00:21:55.140 | it that way before, so after telling the Wall Street Journal that I appreciate their recognition

00:22:00.260 | that we are a private company, it does have a value, very rare, I then take on, I explain

00:22:06.660 | to them, ask them to please explain to me how they got Fidelity in a tie with us, of

00:22:11.220 | course I haven't heard back from them, but it was only six months ago, so we'll be patient.

00:22:17.780 | Now you're wondering, who's the most valuable company?

00:22:22.020 | Any guess out there?

00:22:25.060 | Uber, Uber, Uber, I love to say that, are they coming now Mike, they have all this communication,

00:22:35.540 | there are probably three of them waiting out in front, but a lot of that value has been

00:22:42.380 | created by I think communication, that's the Hamilton part, and I do a lot of papers, journal

00:22:50.460 | papers, which I'm very proud of, 25 in all in these two magazines, 15 in the Journal

00:22:57.620 | of Portfolio Management, and that bottom one, David and Goliath, is a speech I gave in May,

00:23:05.060 | and one of my better ones, if I do say so, we will provide copies to all those who would

00:23:08.940 | like to see them, and they're right there on my website, and Financial Analyst Journal

00:23:14.660 | happened to want an article, I can't remember whether they asked me for the article, no

00:23:19.340 | I think I did it, and sometimes they ask for one, and sometimes I just say here it is,

00:23:24.300 | and they print them, I think, a little casually, but that's their problem, and so I think acceptance

00:23:32.760 | in the academic community is a very, you don't think much about it, and you don't hear much

00:23:37.220 | about it, but it's a very important part of Vanguard's standing in the world's eye, standing

00:23:45.300 | up to the academic challenge, and we do that well, and I will say quickly that in that

00:23:51.120 | David and Goliath speech, I took a shot at Professor Andrew Lowe, who is the king of

00:23:56.820 | the academic finance guys, a professor of MIT, and he had written some stuff, so I just

00:24:03.820 | took issue with, and I sent a copy of the speech, I didn't want to do it on his back,

00:24:08.260 | he was late getting to the point of the Q group meeting where I spoke, and he didn't

00:24:12.820 | get out until the next day, and he sent me this lovely letter, two page letter, thanking

00:24:19.660 | me for being so gracious about my dissent, he thought I made a lot of good points, and

00:24:24.740 | I should know that the Lowe family has lots of money invested in Vanguard funds, go figure,

00:24:38.380 | so the books of course are another huge communication thing, and it's amazing to me, that little

00:24:47.300 | book of common sense investing, and when Wiley told me they wanted me to do it, I said you

00:24:52.300 | know I don't really want to do it, there's a lot of ego here, but I'm the only one

00:24:56.900 | that can write the kind of book that investors want to have, so I wrote it in a much more

00:25:00.300 | simple way, much shorter way, shorter words, shorter paragraphs, and it's been the number

00:25:07.180 | one bestseller for almost nine years now, for more than nine years, and 216,000 copies,

00:25:14.620 | typical investment book sells 3,000 copies, and the reviews are fantastic, and they get

00:25:20.140 | better, the 2016 reviews, 72 on that note here, are the highest, much higher, say the

00:25:28.460 | first two reviews I got, not a lot higher, but higher, so it's very gratifying, and

00:25:34.420 | we'll probably go ahead and do another copy of that book on its 10th anniversary, or maybe

00:25:38.260 | 11th, I'm so damn busy, but it's just short, it's simple, it's persuasive, and it's

00:25:44.180 | not all of the book thing, it's, here's just how book sales are in the last few years,

00:25:51.780 | 80,000 copies, and amazingly, Common Sense on Mutual Funds, a complex book, and it came

00:25:59.740 | out in a 10th anniversary edition, and it really helped that David Swenson, the genius,

00:26:04.460 | I think he's a genius, and he's certainly a hell of a nice guy, who runs the Yale Endowment,

00:26:08.580 | most successful endowment in America, and I wrote a foreword to it, so I've got Swenson

00:26:14.420 | on my side, and I've got Buffett on my side, but I've got Bill Bernstein on my side,

00:26:21.660 | and Peter Bernstein, and God knows who else, Andy Lowe, I suppose, who can be against this?

00:26:31.540 | So all my books together come out to about 895,000 copies, and I suppose if I could live

00:26:37.780 | to about 130, which seems unlikely, we would cross the million book sales mark.

00:26:48.620 | But I'm not the world's greatest writer, but I know how to write, and I know how to write

00:26:58.060 | expository prose, it's a lot easier to do what I do than write a novel or something

00:27:02.240 | like that, which I have no intention of trying, because I'd be totally incompetent, but I

00:27:06.460 | really am proud to have those books, and sort of a monument to be around for a long, long

00:27:11.540 | time.

00:27:12.540 | You'll notice at the bottom there is a book called Enough, and I want to say just a word

00:27:17.940 | about that, not yet.

00:27:22.260 | I showed you this slide last year, and it has a rival.

00:27:30.080 | Somebody else is trying to grab my territory, and a year ago, when I showed you this slide,

00:27:35.820 | you all laughed.

00:27:37.420 | You laughed.

00:27:39.020 | You're not laughing now, slide.

00:27:55.140 | I've had so damn much fun in this life, it shouldn't be allowed.

00:28:01.420 | So let's take a look at Vanguard, Vanguard's growth, and I think at the end of this section,

00:28:05.940 | we'll take a little break for you and me, and show you about 15 minutes of video.

00:28:13.220 | Mike Nolan put it together, he was still working on it this morning, he's a worker, that guy,

00:28:20.460 | and so we're going to show you that.

00:28:21.460 | We'll have a little break, but I'll do this one first.

00:28:24.140 | And let me say, the Lord did not put me on this earth to run a three and a half trillion

00:28:30.060 | dollar company.

00:28:31.540 | I had many more questions about size than I had no interest in bragging about size.

00:28:37.720 | It's a greater responsibility, and for me, a constant worry.

00:28:43.220 | And when I say constant, where was it that I first started to really speak out about

00:28:49.740 | the problems Vanguard might face when it grew?

00:28:53.860 | Well, I gave a lecture to the crew, and it talked about growth, and the value of growth,

00:29:05.340 | and that we better be careful, lest we look like some giant insurance company, mutual

00:29:10.860 | insurance company, where nobody cares about anybody, nobody knows anybody, and everybody

00:29:15.820 | does what they're told, comes in at nine, leaves at five every day, and that's it.

00:29:22.300 | That's not the kind of company I wanted to have.

00:29:23.860 | I wanted the crew to be involved, not automatons, and yet even when I gave this talk, I was

00:29:31.460 | worried about what comes with growth, is, well, you'll hear it right now in this quote

00:29:38.940 | from the speech, and that is, "For God's sake, let's always keep Vanguard a place where judgment

00:29:45.740 | has a fighting chance to triumph over process."

00:29:49.740 | Well, believe me, process grows as a percentage of what you do, and judgment shrinks.

00:29:57.420 | The bigger you get, it's not anybody's fault.

00:29:59.600 | You can do things to hold the tide back, but it's, you know, you can do a little bit better

00:30:03.940 | than King Midas did, but it gets harder and harder as you grow.

00:30:08.520 | So when was that, when did I worry about that?

00:30:12.540 | 1997.

00:30:14.400 | What were Vanguard's assets in 1997?

00:30:16.140 | This is in one of my speeches and character counts, $47 billion.

00:30:23.460 | So if I'd said $3.5 trillion in that speech, everybody would have thought I had maybe one

00:30:28.300 | martini too many, but I've always been worried about it, and I think President Manning doing

00:30:35.740 | as good a job as can be done in trying to keep the place human, keep small groups together,

00:30:42.660 | try and have a bunch of small little companies in this large corporation, and we're not really

00:30:47.420 | huge, 15,000, I guess it is 16,000, I think they say, crew members all over the world,

00:30:53.940 | and it does get harder, and you work at it, and so, and I work at it.

00:31:03.740 | I should tell you that I spend a lot of time, probably at least, say, 25%, Michael, maybe,

00:31:09.980 | 25% of my time working with the crew, one-on-one, I meet an hour with each work for excellence

00:31:15.020 | winner, they bring team meetings into my office, I do 25th anniversaries, 30th anniversaries,

00:31:22.060 | retirements, and it gives me a chance to appear before them, my fellow crew members, and let

00:31:27.460 | them know that there's a living human being still hanging on, trying to keep this place

00:31:31.500 | personal, warm, and friendly.

00:31:35.300 | It's not easy, but we do it.

00:31:38.700 | So the domination of Vanguard begins with the, really, the first, the huge impact of

00:31:46.300 | indexing that we have, and we have dominated industry cash flow, and industry took in the

00:31:52.180 | last year, 12 months, $178 billion, of which $269 billion was Vanguard.

00:32:03.180 | So all of our other competitors put together had $91 billion going out, and we had $269

00:32:10.260 | billion.

00:32:11.260 | And the cash flow keeps growing, as you'll see in this next chart, and you can see it's

00:32:16.740 | driven by, look at that blue part of the stack, it's clearly driven by stock-and-bond funds,

00:32:25.180 | index stock-and-bond funds, and the money market funds, were actually quite dominant

00:32:30.220 | in '98 and '99, '98.

00:32:32.460 | You can't see it here, they're certainly our biggest sector, and they've kind of vanished

00:32:38.580 | from the scene, and now are leaking quite badly within their federal regulations.

00:32:43.780 | So I was really amused by this.

00:32:47.220 | You've heard the expression, "Our growth is off the charts."

00:32:50.260 | Well, in fact, our growth is off the charts, and therefore, when Morningstar put this report

00:32:57.380 | out, my headline is "Where's Vanguard?" taken after "Where's Waldo?"

00:33:02.500 | You'll see the underline, "Vanguard is not displayed in Exhibit 6," because it would

00:33:07.100 | dwarf all the other data points and decrease the chart's legibility.

00:33:12.300 | Now, that isn't the ultimate accolade, but I roughed this out, and I think the Vanguard

00:33:20.000 | stack on this would be maybe 9 inches tall, just to put it in perspective, so you can

00:33:27.780 | imagine how all these would have to shrink to get us on the page.

00:33:30.940 | So the rise of Vanguard has been incredible, $3.5 trillion, you can see we've gone from

00:33:39.340 | way behind Fidelity, minus $204 billion at the beginning in 2000, and when you go from

00:33:47.900 | $204 billion behind a competitor to $1.8 trillion ahead of them, that's quite a shift in leadership.

00:33:58.900 | So the market share grows, and you can see we went through hard times after we started

00:34:03.540 | the firm.

00:34:04.540 | I referred to them.

00:34:05.620 | Market share dropped by pretty close to a third, and then it started going, it's been

00:34:10.140 | going ever since, just by staying the course, giving us that momentum.

00:34:14.340 | To a dominance that's totally without precedent in terms of its industry leadership.

00:34:20.540 | For those of you who are interested in knowing who the previous industry leaders were, Mass

00:34:25.260 | Financial Services was a leader for 17 years, and it got all the way up to a 15% market

00:34:32.080 | share.

00:34:33.080 | Ended in 1952.

00:34:35.640 | Investors Diversified Services, now called Columbia, called American Express went away,

00:34:39.780 | they've had more name changes than you can imagine, and more discontinuities.

00:34:44.140 | They have a huge direct selling organization, they've had that kind of an organization since

00:34:49.980 | 1904.

00:34:50.980 | They weren't selling mutual funds then, they were selling base amount certificates, which

00:34:55.740 | were kind of a rip-off.

00:34:57.900 | And they held the industry leadership for 29 years, no stopping them when you've got

00:35:03.780 | all your own controlled sales force, the rest of us were working through brokers, by and

00:35:07.780 | large.

00:35:08.780 | Columbia Fidelity gets to 13.8%, takes 15 years, we've held that leadership for 15 years

00:35:15.460 | up to 13.8%, and then starts to drift below by the time you get to 2003.

00:35:22.860 | And then Vanguard, and we've been up there 12 years now, the largest firm in the industry.

00:35:27.700 | And our peak market share, look at that, almost 23% when the previous high was less than 16,

00:35:34.740 | uniformly less than 16.

00:35:36.660 | So we've disrupted the industry, I think it's fair.

00:35:41.020 | And it's all based on index funds, almost all.

00:35:44.340 | And you can see the index share of our business in this chart, it's gone from zero in 1975

00:35:50.780 | to 37% of our total of industry assets, I should say.

00:35:58.260 | And gradually, zero, four, 16, 37, and three firms dominate that cash flow.

00:36:06.220 | And that's what's made the difference in growth.

00:36:08.540 | We have Vanguard with 70% of its growth, 70% of its assets in index fund.

00:36:12.940 | Fidelity with only 14, they don't really have their heart in it.

00:36:17.100 | As I've said to people, if you're a missionary, have missionary zeal with this once untested

00:36:24.660 | idea, is it at least possible you will do better than someone who is dragged into that

00:36:30.780 | arena kicking and screaming and hating every minute of it?

00:36:33.820 | You know who to bet on.

00:36:35.580 | And you'll be right.

00:36:36.580 | They're only 14%, but they're our biggest competitor in indexing, in the traditional

00:36:42.160 | index fund field.

00:36:44.060 | BlackRock 68%, that's basically an index fund, started with ETS.

00:36:48.620 | That's just what they do.

00:36:50.660 | American Funds has this professional aura about them, and they're not going to cross

00:36:53.340 | that line yet.

00:36:57.340 | And State Street, of course, is a rapid turnover ETF business.

00:37:04.860 | And every year, State Street, every day, I should say, that State Street index fund,

00:37:13.580 | Standard & Poor's, SPDR, is the most widely traded stock in the world, the most widely

00:37:19.380 | traded stock in the world in terms of dollar volume.

00:37:22.420 | I think that's an uninteresting business.

00:37:25.180 | Trading is a losing game, finally.

00:37:27.140 | The big shareholders in all these ETFs, the big ETS, our exchange-traded funds, our banks

00:37:33.580 | and other financial institutions are trading with one another.

00:37:36.620 | And I'm not the smartest guy in the world, but I know that both sides do not win.

00:37:40.540 | Am I doing OK?

00:37:43.540 | So that's been a huge portion of what we do.

00:37:48.660 | I think we'll pause and give you a little relief, and I'll have some coffee, and Mike

00:37:54.780 | will turn on the video.

00:38:00.260 | Well, we actually got quite a number of questions about whether the popularity of index funds,

00:38:11.020 | you know, they're pretty ubiquitous at this point, actually might be problematic, or whether

00:38:15.740 | index funds work in this more volatile market environment.

00:38:19.100 | So how would you respond to that?

00:38:20.980 | Well, indexing, take the market environment, the easy one first, indexing works in all

00:38:26.940 | environments.

00:38:27.940 | You just have to understand one simple thing.

00:38:31.140 | All of us investors own all the stocks in the stock market.

00:38:34.900 | And so those that are indexed own them in their proper proportion of market value, capitalization

00:38:39.940 | weight, where things like Google and Alphabet, as it's now called, are the largest.

00:38:45.940 | And everybody owns two-thirds of that, everybody but the indexers, roughly.

00:38:50.740 | And the index owns one-third.

00:38:52.500 | So it's volatile for us, the index fund, it's volatile for the investors.

00:38:57.380 | They're all one, because investors own the market.

00:39:00.420 | And they can either do it the intelligent way, own an index fund that holds it, or trade

00:39:04.800 | with one another.

00:39:06.460 | And one trader trades with another trader.

00:39:09.460 | It must be obvious there can be no value added there, just who owns the stock.

00:39:13.100 | Ah, but there is something nice going on here for Wall Street.

00:39:17.460 | The man in the middle, the broker in the casino, the guy with the rake, takes his share out.

00:39:26.300 | So the other investors, the non-index investors, are playing a loser's game.

00:39:32.100 | And people have figured that out.

00:39:34.540 | And I get letters pretty close to every day, Rebecca, saying, I wish I'd read your first

00:39:40.100 | book earlier.

00:39:41.100 | That's now 20 years old, 25 years old, I guess, almost.

00:39:45.180 | And I wish I'd listened to your ideas earlier.

00:39:48.420 | Or I did, and I'm now retired.

00:40:05.660 | Our next question, shifting gears from retirement, is from Chris in San Jose, California, who

00:40:11.180 | says, "Congratulations, Mr. Bogle.

00:40:12.900 | May you live longer and provide sensible financial guidance to us all.

00:40:16.300 | I have two sons, ages 23 and 20.

00:40:19.540 | So what is the one single piece of advice you'd give them so that they are financially

00:40:22.660 | secure when they retire?"

00:40:24.100 | So what's the one thing investors just getting started, right out of college, really should

00:40:28.340 | know?

00:40:30.020 | Start to invest now.

00:40:33.700 | Continue to invest as you have the money.

00:40:37.020 | Increase your investments as you make more money.

00:40:39.780 | Have a little note in your budget so that, let's say, 15% of your compensation goes into

00:40:47.460 | a mutual fund investment, a low-cost mutual fund investment, or even better, an index

00:40:51.460 | fund investment.

00:40:53.500 | And that's only because I believe in it.

00:40:54.940 | I'm not trying to sell anything.

00:40:55.940 | Well, that's okay.

00:40:56.940 | You can sell.

00:40:57.940 | It's a Vanguard webcast.

00:40:58.940 | But make sure that your contributions go up with your income.

00:41:05.180 | And then, you know, I would say another rule that I use, it's a little overdone maybe,

00:41:12.100 | don't peak, P-E-E-K.

00:41:16.460 | Don't look at your account every day.

00:41:17.820 | Don't look at your account every month.

00:41:20.080 | I tell people that if they don't look at it, they start investing when they're 22 years

00:41:24.620 | old and they don't peak at their 401(k) statement or IRA statement until they retire, a caution.

00:41:34.380 | Have a good cardiologist next to you because when you open that final statement, you're

00:41:38.260 | allowed to open it at the end, you will probably have a heart attack.

00:41:41.880 | You won't believe how much money you've accumulated.

00:41:44.260 | It's so remarkable what long-term compounding plus, well, the magic of long-term compounding

00:41:51.780 | returns without the tyranny of compounding costs is magical mathematics.

00:42:02.100 | And if you're aware of that, that's really all you need to know.

00:42:08.540 | Start early, save often, and don't look.

00:42:10.420 | Yep.

00:42:11.420 | Sounds good.

00:42:12.420 | All right, let's take another live question.

00:42:27.540 | This is a good one and certainly a lot of sentiment around this.

00:42:31.380 | This is from Loretta and she says, "Everyone is saying that the markets are currently in

00:42:35.300 | a state we've never seen before.

00:42:37.180 | Do you think we can still rely on the historical principles we have always relied on today?

00:42:42.740 | Is it different this time?"

00:42:45.820 | This time is not different, but stock valuations are higher than they've been and the prospects

00:42:53.820 | for the future are lower than they have been in a long, long time.

00:42:57.620 | You know, in the period I've been in this business, the stock market has averaged a

00:43:02.380 | return of about 12 percent a year.

00:43:04.540 | And that's just not going to happen again, because at that time, during that period,

00:43:10.340 | the dividend yield, and a very important component of stocks, stock returns, was about almost

00:43:15.460 | 6 percent.

00:43:16.460 | Call it 5.5.

00:43:17.460 | Now it's 2.

00:43:18.460 | That's a deadweight loss.

00:43:20.820 | The average earnings growth was pretty close to 6 percent.

00:43:23.400 | I don't see that earnings growth happening in the future.

00:43:25.700 | I think it'll be, if we're lucky, 4 percent.

00:43:28.740 | And stocks have high valuations.

00:43:30.740 | The price earnings multiple, the essential nature, the essential measure of value, is

00:43:35.980 | around 22 times earnings, and the norm is about 16.

00:43:39.580 | So putting those three things together, they're all dear, expensive, if you will.

00:43:44.420 | And so we can look for maybe stock returns on a balanced basis.

00:43:47.620 | And interest rates are 5.5 percent during that long period of my time in this business,

00:43:53.980 | and now they're 2 percent, actually 1.6 percent on the 10-year intermediate term treasury.

00:44:01.500 | And so bond returns will be lower.

00:44:03.980 | So I think that we'll be lucky to get a return of 4 or 5 percent from a balanced portfolio

00:44:08.760 | in the next decade.

00:44:09.760 | I don't look at this, and I don't want the viewers to look at it, as saying he's predicting

00:44:14.460 | something for the year.

00:44:15.860 | I have never predicted anything for the year.

00:44:17.620 | I don't believe in year-long.

00:44:19.140 | Too many things can go wrong.

00:44:20.540 | But in the long run, and this gets to the heart of that question, the same reason for

00:44:25.980 | generating returns, the reason for generating, that stocks generate returns, is the same

00:44:30.700 | as it has always been, the earning power of corporations.

00:44:34.940 | They make earnings.

00:44:36.400 | They pay some out in dividends.

00:44:38.300 | They reinvest to build newer, faster, innovate, whatever they do.

00:44:44.060 | And that's where earnings growth comes from, from that reinvestment, by and large.

00:44:47.820 | So dividend yields are lower, and the reinvestment will be lower.

00:44:52.260 | And so the returns will be lower.

00:44:54.400 | I think that's almost certain.

00:44:56.500 | And so just relax, because the one thing that will guarantee your retirement plan will have

00:45:03.540 | an asset value of zero is don't invest at all.

00:45:08.580 | True.

00:45:09.580 | Yeah.

00:45:10.580 | Actually, you should save more.

00:45:11.580 | Yep.

00:45:12.580 | And what's hard, and I think very important for the audience to understand, is you have

00:45:17.500 | to accept the market returns for what they are going to be.

00:45:21.020 | Don't reach beyond them.

00:45:22.340 | Don't do something speculative.

00:45:24.060 | Don't lever up to make up the difference.

00:45:26.280 | It just is highly unlikely to pay-- well, it certainly will not work for everybody,

00:45:30.940 | and highly, highly unlikely to work for very many people.

00:45:33.580 | So, Mr. Bogle, we have actually gone over time.

00:45:50.740 | Obviously, thousands of questions and tweets left.

00:45:52.740 | Maybe we can get you to answer a few tweets after the end of the broadcast.

00:45:55.900 | But I did want to give you the opportunity to have some final thoughts, and you can share

00:45:59.860 | them right with the shareholders that are watching, if you'd like.

00:46:02.540 | Sure.

00:46:03.540 | Well, I think I've had a great time in this business, almost unimaginably great.

00:46:09.740 | I've accomplished something that has not been done before.

00:46:13.220 | The idea of index fund investing is kind of taking over the world, and it is taking over

00:46:18.020 | the world.

00:46:19.020 | And it's going to continue, by the way.

00:46:20.020 | I warn my actively-managed competitors, they're going to have to do something somewhere to

00:46:24.180 | protect themselves.

00:46:25.180 | But the whole core of everything we do here, most notably and easily measurable in indexing,

00:46:32.100 | is putting the client first and giving you your fair share of whatever market returns

00:46:39.220 | develop.

00:46:41.020 | They may be good, and they may be bad, and I warn you that owning an index fund is not

00:46:46.460 | a free ride to prosperity under all circumstances.

00:46:51.300 | When the markets are bad, and they will be bad from time to time, particularly in the

00:46:54.440 | short run, the index fund will give you your fair share of those bad returns.

00:46:59.500 | So don't think of it as a miracle.

00:47:01.620 | Think about it as an intelligent policy that puts you in the focus of the system.

00:47:07.180 | And fortunately, again, Vanguard's structure, we're able to deliver on that promise, a mutual

00:47:12.220 | company in which the shareholder comes first, last, and always.

00:47:17.500 | Or as I would put it in a more simple way, you'll recognize the cadence, Vanguard is

00:47:21.660 | a company of the investor, by the investor, and for the investor.

00:47:28.300 | And you all are those investors.

00:47:30.900 | And I thank you deeply for your kind comments about me, and I thank you for your confidence

00:47:35.060 | in me and in Vanguard.

00:47:47.700 | I should say that that last little segment was totally un-tipped off to me, and I was

00:47:54.740 | going to get that question at the end, totally unscripted and totally unrehearsed, and I

00:47:59.340 | think it's better than what I do when I'm totally scripted and totally rehearsed.

00:48:03.780 | Joining us now to discuss the future of indexing and what lies ahead for active management

00:48:10.100 | is the one and only Jack Vogel.

00:48:12.460 | He joins us from Valley Forge, Pennsylvania.

00:48:14.660 | Jack, great to see you.

00:48:16.340 | Thanks so much for joining us.

00:48:18.260 | The numbers here, when it comes to passive investments, are staggering.

00:48:23.060 | Since 2008, active funds have seen $600 billion in outflows.

00:48:27.900 | $261 billion, meantime, have moved into index funds.

00:48:31.540 | Bill Ackman recently referred to an index bubble.

00:48:35.140 | What part of the rise of indexing has caught you by surprise?

00:48:38.820 | Well, I guess it's strength, although I'm disappointed by how long it took.

00:48:44.860 | You know, 40 years is a long time, and it actually took until the mid-90s.

00:48:48.780 | We started the fund in 1975, and it took until the mid-90s before indexing caught on.

00:48:54.900 | Then it caught on with a real flourish, and now totally dominates the industry.

00:49:00.180 | In an industry in need of some creative destruction, we're destroying a lot of old tenants, old

00:49:07.420 | ideas, and making life difficult a little bit for active money managers with high costs.

00:49:13.560 | Active money managers with low costs are doing a little bit better than that.

00:49:16.980 | There's been a bit of criticism brewing, I'm sure in part because of that success, Jack.

00:49:23.340 | In fact, recently an analyst at Sanford Bernstein wrote a note saying that index investing is

00:49:28.060 | worse than Marxism.

00:49:31.660 | I'm sure you've seen, I'm sure you've heard these kinds of criticisms before because,

00:49:37.540 | you know, index investing doesn't participate in the price-setting mechanism.

00:49:42.060 | How do you feel about that accusation, though?

00:49:44.980 | Well, I don't know that I can find the right words.

00:49:49.140 | "Idiotic" would be one, and "totally wrong-headed" would be another, a silly attempt to get across

00:49:57.060 | an argument that is terribly flawed.

00:50:01.460 | The article, the Marxist article, if you will, says that any field of endeavor that subtracts

00:50:08.820 | value from society is doomed to fail.

00:50:11.540 | Well, index funds, indexing in general, particularly in the mutual fund industry, is adding huge

00:50:16.500 | amounts of value to our society, to investors, so if they don't understand that, I'm not

00:50:23.060 | sure what they do understand.

00:50:25.420 | And it's a funny article, it's long, detailed, I'm not sure how many of the readers can get

00:50:32.340 | through all those, or can understand all those formulas that are printed page after page,

00:50:38.140 | and the comparison with the financial business to the mining industry struck me as absurd

00:50:44.300 | until I realized they were both extractive industries.

00:50:48.300 | The mining industry is taking gold and coal out of the ground, and the financial industry

00:50:54.100 | is extracting value from the clients it serves.

00:50:58.900 | At what point does indexing make the market much less efficient?

00:51:04.220 | And the reality is that you could get to, right now, indexing is around 30% of the total

00:51:09.340 | market.

00:51:10.340 | I'm sure you can get to 50 or 60% before anything would even be noticed, because the indexes

00:51:16.180 | just remove a certain portion of the market from trading activity.

00:51:20.260 | And if it got to 90 or 95%, it would be, it might, at least, make it easier for active

00:51:27.220 | managers to win, or so it is alleged.

00:51:30.420 | What the people that say that don't get is when the market is less efficient, it's easier

00:51:36.060 | for the good guys to win, and it's easier for the bad guys to lose.

00:51:40.420 | They have to balance each other out.

00:51:42.380 | There's just no way around that.

00:51:44.060 | So I just fall back on the simple mathematics.

00:51:47.100 | I don't worry about it.

00:51:49.020 | It doesn't seem to have any dire effects so far, and the reality is that year after year,

00:51:55.460 | in terms of performance and investment returns, indexing outpaces active managers.

00:52:01.860 | And this year, it's like 8% for the S&P 500, 6% for the average large-cap growth fund.

00:52:08.060 | That's a huge, it's a 33% margin, 6 over, compared to 8.

00:52:12.580 | And the reason it's not mysterious, it has nothing to do with being smart or dumb, it

00:52:16.220 | has to do with taking costs out of the equation.

00:52:20.500 | And those costs are fund expense ratios, and those costs are fund turnover, and the fund

00:52:25.700 | industry turns over its portfolios a lot, and when you don't know how much that is,

00:52:29.700 | you know it's large.

00:52:31.500 | And if you take those two numbers together, you're going to pick up about 2%, or 2% on

00:52:36.540 | a properly constructed comparison, should be the margin by which an S&P 500 fund beats

00:52:42.140 | the average large-cap fund.

00:52:43.860 | It's as simple as that.

00:52:45.460 | And I'm glad Jack mentioned costs, because fees, of course, for active funds were $0.99

00:52:49.540 | in 2000.

00:52:50.540 | They've since dropped to $0.77 today.

00:52:53.520 | That's really the Vanguard effect at work.

00:52:55.060 | Great.

00:52:56.060 | And Eric Balchunis wrote a story about the Vanguard effect just a couple of weeks ago,

00:53:01.060 | and Jack, he estimates that you and Vanguard have saved investors about a trillion dollars

00:53:07.020 | over the last four decades.

00:53:09.300 | Do you reckon that's a fair calculation?

00:53:12.940 | Actually, I think it may even be, believe it or not, understated, because they compare

00:53:19.380 | our expense ratios with the average of our competitors, and the fact that we aren't trading,

00:53:25.060 | which is a huge cost saving, but they don't take those savings each year and earn a return

00:53:30.500 | on the accumulated savings, in other words, the cost of capital kind of an argument.

00:53:34.660 | So if you put some kind of a return on the money that we save investors each year, and

00:53:40.100 | look at it over 20 years or so, you find a huge and staggering number, whether a trillion

00:53:45.500 | is the right number or a trillion and a half, I wouldn't know.

00:53:48.860 | But it's big, very big, and it's good for the investor.

00:53:52.540 | That's the important thing.

00:53:54.100 | Okay, I'm buying it.

00:53:59.140 | I believe!

00:54:01.180 | You know, these things are, I've been accused of, even in my books, of just selling my own

00:54:17.500 | ideas to help Vanguard, and that really has nothing to do with my motivation.

00:54:24.740 | We don't need any more money coming in.

00:54:26.340 | We don't need any more sales.

00:54:27.860 | We're happy to have what we have.

00:54:30.340 | I'm doing this because I am passionate about it, and it's true, and it works.

00:54:36.820 | So what the heck are you supposed to say?

00:54:39.740 | You know, I can't say, well, you know, investment management and active management will win.

00:54:44.620 | A few will win here and there.

00:54:45.860 | I'll talk about that later.

00:54:47.660 | And they're never seen again.

00:54:48.660 | I mean, think about something like Magellan with a $120 billion fund, and now I think

00:54:54.100 | it's eight.

00:54:56.020 | That's a lot of disappointment.

00:54:57.580 | Actually, if I was better, I could tell you it was $112 billion worth of disappointment.

00:55:04.540 | But in any event, we'll now turn to part three of the changes in the fund industry, and I'm

00:55:09.700 | going to go pretty quickly here, because I don't want to run, when's my time up?

00:55:15.380 | Oh, I've got until 9.25.

00:55:17.540 | I might even be able to finish this, but maybe I can get an extra couple of minutes.

00:55:22.500 | So what's happened to this industry since I joined it all those years ago?

00:55:29.340 | Here I am in my 60th anniversary.

00:55:33.060 | Industry leadership.

00:55:34.100 | The industry has grown, number one, and it's grown in a very different way from domination

00:55:40.060 | by money market funds, which was about half of the industry at one point here, and then

00:55:45.340 | all of a sudden, the long-term index funds, you can see that green line, and it's only

00:55:50.020 | a matter of time since the index funds will be, well, those are all equity funds there,

00:55:58.140 | 37% equity fund assets are indexing, and back in the day, there was not even an index fund.

00:56:04.460 | So we have today $3.1 trillion.

00:56:08.820 | We use different numbers on these, 78% equity and 22% balance, so balance and bond, I guess

00:56:18.660 | that is, and so we're growing at 14%, and that doesn't seem to show that, but the industry

00:56:25.140 | has changed.

00:56:26.140 | Think about changing leadership.

00:56:27.740 | MIT, now MFS, has dropped out of the top 10.

00:56:31.660 | They still make a lot of money for their parent companies, Sun Life of Canada, and they don't

00:56:36.340 | do so well for their shareholders.

00:56:38.340 | Vanguard has gone from Wellington Fund number six to number one.

00:56:42.620 | Fidelity wasn't even on the chart in 1951, although we sort of knew they were a competitor

00:56:47.180 | to number two.

00:56:48.660 | BlackRock didn't even exist back then.

00:56:51.100 | The American funds did exist, although they were too small to be here.

00:56:54.340 | They were probably $3 million back in 1951, something like that.

00:56:58.860 | The numbers are really remarkable, and State Street knew, J.P. Morgan knew, On the Bandwagon,

00:57:04.820 | Tin Cone knew, Dimensional Fund Advisors, a very strong competitor, probably one of

00:57:10.300 | our two strongest competitors, actually, and so the industry is less dominated by these

00:57:16.060 | 10 leaders.

00:57:17.060 | They used to be 72% of the total, and now they're 60%, but the change in leadership

00:57:24.500 | is quite striking in the new leaders that come along, including Vanguard.

00:57:29.620 | In this huge growth, expense ratios haven't gone down, which you would think they would

00:57:35.700 | go down, with the economies of scale that are available and rife in this industry, but

00:57:41.660 | the problem is that the investment managers and their parents, the companies that own

00:57:48.380 | them, most of them are owned by conglomerates or by the public, have taken all the economies

00:57:53.420 | of scale and aggregated them to their own benefit rather than the benefit of shareholders.

00:57:58.100 | So you can see, I mean, nobody would believe this, but if you look at just the straight

00:58:01.980 | average of the expense ratios of the funds in '51, .62, it's gone up 72%, even though

00:58:10.660 | the industry has gone up, or this part of the industry has gone up from 1 billion of

00:58:16.860 | assets to 4 trillion of assets, and their expenses have gone up almost the same amount.

00:58:27.300 | So the new model, Vanguard, has assets of 3.5 trillion, a slightly different number,

00:58:33.820 | and expenses are 4 billion.

00:58:36.540 | So the privatization of the industry, indicated by these firms that are in red, has been directed

00:58:41.860 | to the financial conglomerates that own all these firms.

00:58:44.780 | It's pretty disgraceful, because they're in business to make money for themselves and

00:58:49.140 | not for the fund shareholders.

00:58:50.140 | Not that they don't want to make money for shareholders, of course they do, but they

00:58:53.620 | don't want to do it at their own expense.

00:58:55.860 | So this terrible flaw that's brought about this public ownership that you can see there,

00:59:01.260 | private ownership, conglomerate ownership, in red, goes back to 1958.

00:59:07.300 | Very few people know this.

00:59:09.020 | The Supreme Court, the U.S. Supreme Court, determined not to review a decision by the

00:59:15.580 | California Ninth Circuit Court of Appeals that allowed a California company, a very

00:59:21.020 | small one, to sell its trusteeship at a capitalized value of trusteeship, and that shouldn't have

00:59:29.140 | happened.

00:59:30.140 | It was a bad decision, the Supreme Court ratified it, and all of a sudden we have each mutual

00:59:36.100 | fund, except for one, you know what that one is, has two masters.

00:59:40.460 | And as Luke will tell us, "No man can serve two masters, for either they hate the one

00:59:46.460 | and love the other, or hold to the one and despise the other."

00:59:51.100 | And you know who gets the love and who gets held onto, and that's the management company,

00:59:59.380 | because the management company directors control both the fund board and the fund, as well

01:00:03.580 | as the management company.

01:00:04.820 | Yet that's the industry's principal ownership structure, unlike what it was way back in

01:00:10.340 | 1951.

01:00:13.220 | And now we have publicly held companies 11, conglomerates 28, that's 39 companies, ten

01:00:23.700 | are privately owned and one mutual, and that includes the three largest firms in the industry,

01:00:28.420 | which has something to do with one of the largest firms in the industry.

01:00:30.580 | They haven't let the conglomerate be first.

01:00:34.220 | This is a bad change for the industry, and it's almost totally unrecognized.

01:00:39.540 | When I talk to people in the industry, they never heard of the ISI decision, which is

01:00:43.100 | the name of the California case, but it's changed the character of the industry for

01:00:48.500 | the worse at the expense of shareholders.

01:00:51.020 | And then we have, of course, the rise of the index fund.

01:00:53.820 | I won't belabor this one, but since 19, well, if you go all the way back, the industry has

01:01:01.500 | grown at a very healthy 13% rate, traditional index funds, and we don't have any data for

01:01:08.060 | ETFs back there.

01:01:09.060 | But if you look at the last seven years, actually, the traditional index funds are growing faster

01:01:14.700 | than the ETFs, and I think that's as it should be.

01:01:17.140 | ETFs are heavily used as trading vehicles, and that's not the way to success in money

01:01:22.620 | management.

01:01:23.740 | So I think we will see some kind of a shakeout, I'll talk about this at the end, and you really

01:01:28.540 | know all this, the difference between traditional index funds, TIFs, an acronym that has never

01:01:34.500 | been used by anybody but me, but I can still stick to it, so what, and ETS, you know, first

01:01:42.300 | index fund, set the principles, first index investment trust, own the whole market, diversify

01:01:48.620 | the nth degree, minimize transaction costs, tiny expense ratios, and bought to be held

01:01:54.460 | forever.

01:01:56.020 | Exchange traded funds don't have those principles.

01:01:57.900 | Pick your own index, there are only 1,900 indexes represented, so-called indexes, represented

01:02:05.260 | in these ETFs, diversify, but only within the sector you choose, could be very narrow,

01:02:11.140 | lower expenses, higher than the Vanguard prices mostly, but sometimes not particularly low,

01:02:16.820 | over 50 basis points.

01:02:18.520 | And then there's the fringe, the lunatic fringe of ETS.

01:02:22.620 | If you would like to bet on what the market is doing today, and decide in your wisdom

01:02:27.460 | whether it's going up or down, you can do so and get triple leverage on your bet, and

01:02:32.500 | I would call your broker, he's probably there by now, we'll do it at the first break, and

01:02:40.460 | tell me, William, whether you picked up or down.

01:02:43.380 | What a way to run a business.

01:02:45.140 | I mean, it's lunatic, but not all ETFs are the same, I think we're doing the best job

01:02:52.900 | of any of them.

01:02:54.060 | I have my questions about ETFs, as everybody knows, and everybody laughs at me, you know,

01:02:58.820 | they are a very important marketing element, but our turnover, 200%, is far below, look

01:03:07.060 | at State Street, 2,200%, all the big guys have about a 900% turnover, and these little

01:03:15.260 | nuts have a turnover of 4,952%.

01:03:23.380 | It just makes no sense at all.

01:03:26.100 | They're marketing gimmicks.

01:03:28.920 | So it's the ETF that provides long-term consistency, maximum consistency for a long-term investor,

01:03:35.540 | and that's the secret.

01:03:37.140 | So that's a change, and I hope people are using ETFs wisely, and I will tell you that

01:03:43.020 | there are plenty of perfect good uses for ETFs, just don't trade them.

01:03:47.500 | Exchange-traded funds are fine, just so long as you don't trade them.

01:03:52.020 | Now that isn't an oxymoronic statement, I don't know what is, but it is the traditional

01:03:58.340 | index fund that's had remarkable consistency, you see it in this chart, and we redid that

01:04:04.420 | chart I gave to the board back in 1975 to endeavor to persuade them that this was a

01:04:10.860 | good idea, and the index had beaten an essentially large-cap group of mutual funds, which is

01:04:18.340 | why the industry was almost entirely at 1.6 percentage points a year.

01:04:23.580 | We redid that, and it's just an accident.

01:04:26.260 | The market did almost the same in the second 30 years as the first 30 years, 11.3%, 11.2%.

01:04:32.860 | It's just crazy that it's that close, but look at the difference, 1.6 percentage points

01:04:38.360 | in each period.

01:04:39.880 | So we've now done this for 60 years, and if that's not persuasive, I don't know what to

01:04:44.980 | say, and the index is just the right way to go.

01:04:52.140 | And you'll notice that we've shifted there, the average large-cap fund, because this industry

01:04:57.180 | is so diverse, that's the fair comparison, and you'll see that standard deviation, the

01:05:06.660 | index is just a hair more volatile, and look at the R-squared.

01:05:12.180 | How much of the return of the average large-cap mutual fund is explained by the motion movement

01:05:19.620 | S&P 500%, 99% for the funds on average, and the index fund can only do 100%, having explained

01:05:29.200 | by the index.

01:05:30.500 | So it's a very fair comparison, and those numbers prove it, and prove the success.

01:05:37.340 | So the question is, can you do better?

01:05:40.500 | Pick the right manager.

01:05:41.500 | People say that beating the market, well this is a chart from Morningstar, Vanguard did

01:05:48.500 | some editing of it, but it's still correct.

01:05:51.140 | This shows the number of, percentage of active funds in each category, outperforming their

01:05:56.580 | index benchmark, and you see you've got to get all the way over to small growth, really,

01:06:04.420 | some extent small blend at the bottom there, over at the right, to see that in general

01:06:10.740 | about 7% is the chances of winning the game, 11% overall if you count that big 30% at the

01:06:18.380 | end.

01:06:19.480 | So people say, well I'll just pick, this is an interesting chart, I'll just pick the above

01:06:25.540 | average funds, as if the past tells you anything.

01:06:30.420 | And here's how you would have done.

01:06:32.500 | We gave you a similar chart to this last year, for the 5 years ending in 2014, this is ending

01:06:39.940 | in 2015, 5 year return, just look at this, it's amazing.

01:06:44.300 | So you went to the highest best performing funds, in the highest quintile, highest 20%,

01:06:49.740 | and 16% of those funds, 16% of them, repeated, and you've been in the lowest performing group,

01:06:58.580 | 24% of them repeated, your odds were better to pick the lowest performers than the highest

01:07:02.780 | performers.

01:07:04.100 | And then look at down at number 5, the lowest, 15% of them moved to the highest quintile,

01:07:09.660 | 9%, only 9% remained in the lowest quintile, and then look at the frightening thing over

01:07:16.020 | at the side.

01:07:17.620 | Even if you pick a good fund, the odds are 25% would go out of business in 5 years.

01:07:26.060 | Think about that.

01:07:27.060 | It's amazing.

01:07:28.060 | And you can see that the worse the performance has been, since the beginning of the period,

01:07:32.940 | and the greater the percentage gets folded up, 40% of the lowest quintile funds are merged

01:07:40.500 | or closed, and only 13% of the highest quintile.

01:07:43.100 | That's very intuitive, not very hard to accept.

01:07:46.980 | So we have not only index funds, but we have what I started talking about at the beginning

01:07:53.180 | of Vanguard, before we even had an index fund.

01:07:55.980 | What we want to accomplish here is to give our funds relative predictability, relative

01:08:01.380 | to their market standard, market index they match, or their competitive group.

01:08:06.520 | Relative predictability, because if you get very good, you're going to be very bad, and

01:08:10.300 | the money comes in when you're good, and bad when you go out.

01:08:12.580 | So it's the right thing to do for investors, and it's the right strategy for the firm.

01:08:17.100 | So relative predictability goes way beyond the index funds for Vanguard.

01:08:21.940 | I'll show you some numbers on that, but 91% of our assets have very high relative predictability.

01:08:30.260 | They're average pre-cost returns, and they're superior post-cost returns.

01:08:33.900 | You know, if you can be average, if we can be average, and are taking an expense ratio

01:08:38.220 | of 25 or something, 35 in our actively managed funds, and 5 in our index funds, you're going

01:08:43.940 | to beat everybody else who's charging 100 basis points, give or take, and has very high

01:08:48.820 | turnover costs, which the index fund lacks.

01:08:52.260 | So I calculated 19% of our assets are in what I call virtual index funds, or relatively

01:09:00.400 | predictable mutual funds.

01:09:02.300 | And here's how they look.

01:09:03.300 | I mean, it's kind of amazing.

01:09:06.380 | Relative predictability is going to high R-squared, high amount of funds returned, the percentage

01:09:11.540 | of the fund returned.

01:09:12.540 | It's explained by the action of the market.

01:09:15.140 | And you can see the index funds, 199.

01:09:17.940 | But the active funds, look at the active funds, Star, link 99, Correlation, Explorer 99, Wellington

01:09:25.380 | Fund, 98% of its return is explained by its index, which is 35% Corporate Bond Index,

01:09:37.020 | and 65% S&P 500, 98%.

01:09:40.380 | It's managed to the tune of 2%.

01:09:42.540 | Can't get very far out of line.

01:09:44.620 | And so on down, on average, taking all our equity funds, we have 96 correlation.

01:09:52.740 | And even the industry is at 92.

01:09:54.980 | These people are all basically selling the market, but they're charging you as if they're

01:09:58.740 | geniuses.

01:09:59.900 | And that can't go on forever.

01:10:02.340 | Now let's take a look at how funds do.

01:10:06.900 | And you can see the relationship of cost in the far right column to the net positive score.

01:10:13.940 | And you'll see how many funds each firm has, and we rank them, just add them up and divide

01:10:19.500 | them.

01:10:20.500 | How many?

01:10:21.500 | One and two star, that's the lowest that Morningstar does, and four and five, that's the highest

01:10:25.300 | for Morningstar.

01:10:26.300 | Subtract and get the net.

01:10:27.300 | It's not very complicated, but it's a good system because the Morningstar system itself

01:10:30.980 | is good.

01:10:31.980 | So you can see there's Vanguard at 0.18, 69%, two euro price in a virtual tie or in a tie.

01:10:40.500 | Schwab is better than I would have expected, duh.

01:10:44.340 | Dimensional Fund Advisor is very competitive.

01:10:46.340 | TA Creft, competitive.

01:10:48.740 | And then you get down to Fidelity, and they have a problem.

01:10:52.220 | Not only high expenses, but it's money going in and out.

01:10:56.340 | And they have 25% in the lowest performing group, compared to our 4%.

01:11:03.500 | You win a lot in this world by not losing in the world of investing.

01:11:07.140 | And they have 25% of their funds that have been losing.

01:11:10.220 | Mainstreet Global, kind of normal, shouldn't waste much time on that.

01:11:13.460 | Same for BlackRock.

01:11:15.060 | Wisdom Tree, pretty disgraceful, 33% at the bottom, 36% at the top for a score of two.

01:11:22.900 | But that's good compared to Goldman Sachs, look at them.

01:11:28.340 | Look at them, 62% in the bottom group, 13% in the top group, net score minus 49 percentage

01:11:39.900 | points.

01:11:40.900 | Mass Financial, minus 54.

01:11:43.940 | Franklin Templeton, 64, minus 70% at the bottom, 6% at the top.

01:11:49.940 | No wonder there's kind of a shrinking ship, sinking ship.

01:11:54.180 | And then you have the all-time champion, Putnam, struggling, minus 73%, 75% at the bottom,

01:12:03.180 | 3% at the top.

01:12:04.860 | I don't see how these people get dressed and come to work in the morning.

01:12:08.980 | And honestly, it doesn't look like there's much point.

01:12:12.820 | So the lower the cost, the higher the rankings.

01:12:15.460 | Here's a rough correlation, won't spend much time on this.

01:12:17.620 | It's a little crude correlation, but the correlation between average expense ratio on that chart

01:12:23.500 | and your rating is about 73%.

01:12:26.940 | And so that's a good correlation, but not quite as good as, not quite as even.

01:12:31.820 | There's a lot of variation around it.

01:12:33.940 | Now, you saw American funds way at the bottom of that previous one.

01:12:37.380 | I want to put that back a sec.

01:12:40.580 | You saw American funds at the bottom.

01:12:42.940 | And how could they be so bad?

01:12:45.940 | We have a lot of respect for them.

01:12:47.220 | They're a good firm.

01:12:48.220 | And the answer is that they don't just have the funds you read about in Investment Company

01:12:52.820 | of America, American Growth Fund, and Washington Mutual.

01:12:57.180 | They have a whole bunch of series, all of which have high expense, many of which have

01:13:02.220 | high ratios.

01:13:03.220 | I can show you that right here.

01:13:05.060 | The funds that they track at Morningstar are Class A, and they leave out the sales charge

01:13:10.340 | at 575%.

01:13:12.760 | And then they go to ones that replace that low, with a no-load basis, replace it with

01:13:18.260 | a high expense ratio, 134, 139, 140, 141.

01:13:26.060 | So they have a much higher expense ratio.

01:13:28.620 | They would produce a number of 4.58 for you, and we produce a number on this chart of 0.96%,

01:13:36.340 | almost twice as much.

01:13:38.380 | So they're down there for a reason.

01:13:43.140 | Another big competitor is the FAA, and I'm not going to – I'm going to save this

01:13:47.660 | chart, I think, for Bill and I to talk about it.

01:13:50.400 | We're going to want to talk about Dimensional Fund Advisors when I talk about Bill becoming

01:13:54.020 | a major competitor.

01:13:55.020 | Now, I want to talk about – briefly about Wellington Fund.

01:13:58.820 | And I should tell you this, that when I finally got Vanguard formed, got the no-load, went

01:14:08.420 | no-load, got the index fund started, struggled with all those redemptions, tried to get the

01:14:14.100 | firm going in the right direction, and kept going in the wrong direction, by 1978, I decided

01:14:21.060 | to do what I thought was the highest duty of my career.

01:14:25.980 | Mr. Walter Morgan, the founder of Wellington Fund, loved the name Wellington, and was very

01:14:34.780 | close when he made me the head of the company at age 35.

01:14:37.860 | Of course, I made mistakes, and some pretty serious, but without that dumb merger, there

01:14:43.380 | wouldn't be any Vanguards, and maybe all's well that ends well.

01:14:46.840 | But I put my mind to Wellington Fund and redid the entire basis of – because now we're

01:14:54.980 | the client.

01:14:56.180 | I couldn't tell Wellington what to do when I was running the management company, because

01:15:00.620 | all those geniuses were responsible for investment.

01:15:03.420 | So-called geniuses.

01:15:04.420 | You'll see that record right there, in 1967, 1978, a collapse in Wellington Fund, and this

01:15:11.700 | is its relative returns, relative to the Average Balance Fund, and it took two years to get

01:15:18.180 | going.

01:15:19.180 | We moved into a much more income-oriented, less growth-oriented base.

01:15:23.900 | I even gave Wellington Management a portfolio to show them how to do it, if they couldn't

01:15:28.420 | figure it out.

01:15:29.420 | It's not supposed to be my area of expertise, but it was fun to do.

01:15:33.500 | And did it work?

01:15:34.500 | Look at that.

01:15:36.500 | Look at the renaissance.

01:15:37.500 | It started in 1982 – in 1980, I should say, and it took a couple of years to go, to get

01:15:47.020 | done, to change in the portfolio.

01:15:49.340 | But it's been almost entirely a straight line upward.

01:15:51.740 | And if you look at that recent period, the Wellington Fund return has been 11.4%, compared

01:15:59.420 | to 8.9% for the Average Balance Fund.

01:16:02.140 | That's 2.5% every year.

01:16:05.100 | It's amazing, because our costs are so much lower.

01:16:08.100 | Wellington Fund probably runs 30 basis points, 28, 17 basis points, and the competitors are

01:16:16.820 | charging about 117, and they're turning over, say, costing them 50 basis points a

01:16:22.500 | year.

01:16:23.500 | So they're giving us, say, 1.5% at the beginning of each year, and they're very compatible.

01:16:28.380 | These probably 700 or 800 Balance Funds, the portfolios are all rather similar.

01:16:33.060 | So we're going on the starting line, and some nice guy comes up to me and says, "Mr.

01:16:39.100 | Wellington Fund, why don't you start this 100-yard dash on the 15-yard line?"

01:16:44.580 | "Well, I'll do that if that's what you want, and believe me, when you get a 15-yard

01:16:50.100 | head start in a 100-yard race, even I am not able to lose."

01:16:58.100 | And that whole age from the fund's beginning, you'll see it's quite varied, it's based

01:17:02.180 | on our cost advantage.

01:17:04.680 | So I take this opportunity, and I should do this more often, trying not to forget, and

01:17:10.640 | I never do, the founder of Wellington Fund, and my mentor and my friend, and someone sent

01:17:16.560 | me a magazine article from 1990, when he was 92 years old, on the cover of a local magazine,

01:17:25.620 | and here is Walter Morgan, my great friend.

01:17:29.100 | He was 92 years old then, if you can imagine that, 92, and he would live, his birthday

01:17:35.760 | was July 23rd, Hunter's birthday was July 23rd, 1998, and he died around September 5th,

01:17:42.500 | 1998.

01:17:43.500 | He used to say to me, "Jack, I don't know why the Lord would keep anybody around this

01:17:50.000 | long."

01:17:51.600 | And I said, "Well, you know, I can give you an easy answer to that."

01:17:53.600 | I was forced to call him Walter, which was extremely difficult for me, and I said, "Walter,

01:17:58.720 | I know why the Lord keeps you around this long, because the Lord knows how much I need

01:18:03.440 | you."

01:18:05.240 | In that article, by the way, he's quoted as saying, "His best business decision was making

01:18:09.240 | me the head of the company."

01:18:10.860 | We had a couple of years to get used to that, it didn't work out very well in the beginning,

01:18:14.980 | but he was a wonderful, wonderful man, and so I said, "God bless you, Walter Morgan,

01:18:20.840 | my friend and my mentor."

01:18:24.800 | Never anybody quite like him, and never will be.

01:18:28.580 | Looking ahead, I want to talk about future market returns briefly.

01:18:32.280 | Have we done that, I don't know, I guess I can look, five minutes?

01:18:41.240 | Keep me honest, Mike, sorry.

01:18:45.000 | Okay.

01:18:46.000 | Once invited, of course I will.

01:18:50.000 | And if you read my technical stuff, they gave me this nice chair, you might as well sit

01:19:04.600 | down.

01:19:05.600 | It was an actual page that said something like, "Never stand up if you can sit down,

01:19:11.760 | and never sit down if you lie down."

01:19:14.160 | So I made my attempt at the ladder late in the afternoon yesterday, and I lie down on

01:19:20.000 | the office floor and take a nap.

01:19:23.840 | And it used to be easy, but now I can't get up, I almost have to call for help.

01:19:31.320 | You might as well laugh, crying doesn't do any good.

01:19:35.760 | But the important point is, the returns come from what corporations give us.

01:19:42.360 | And we call that investment return, that's the, if you know my stuff, that's the initial

01:19:46.400 | dividend yield.

01:19:47.400 | Very important when you buy in, the lower the yield, the better, the worse your future

01:19:52.240 | return, relative return will be, and the higher the yield, the better it will be.

01:19:56.360 | And you just add that dividend, we do this I think on a rolling 10-year basis, and then

01:20:00.680 | you add subsequent earnings growth.

01:20:02.760 | And we know the dividend yield, and we know within close ranges what the earnings growth

01:20:07.880 | will be under anything remotely resembling normal circumstances.

01:20:11.560 | And the earnings growth, you know, it really can't be, well in the depression it was never

01:20:15.760 | below let me say 4%, and rarely above 10%.

01:20:19.680 | So you've got a very narrow range to pick your numbers.

01:20:23.840 | And you don't know the future, but you can just take the average for the recent period,

01:20:27.640 | and that's what we do.

01:20:28.840 | But this is the real earnings growth plus dividend yield.

01:20:32.520 | And that corporate return that you get through the stock market, the stock market's derivative

01:20:40.160 | of the value created by American business.

01:20:43.600 | And speculative return is the other important element, but only for a short time.

01:20:49.120 | And you can see those bumps along the bottom, change in the PE on each 10-year period, and

01:20:54.360 | how much it added or subtracted from total return.

01:20:58.120 | You can see there's some tractions anywhere anytime it's below 1.

01:21:02.160 | And so the annual return, basically speculative return in the long run is zero.

01:21:07.680 | It happens to be 3/10 of 1% in this 19, sorry, 116-year period.

01:21:16.240 | So you're relying on fundamentals matter.

01:21:20.280 | And finally, valuations don't in the long run, but valuations are everything in the

01:21:24.320 | short run.

01:21:25.560 | So that is background.

01:21:26.560 | Oh, well, I'll give you this one more chart.

01:21:30.320 | I fuss with this, you know, we know the return on the stock market, we know the return on

01:21:33.800 | the fundamentals, and so we just do that in 10-year moving averages.

01:21:39.840 | And you can see, it's a central point, and that is 10-year returns on average are almost

01:21:46.080 | exactly like fundamental return, almost exactly, market return is almost exactly equal to the

01:21:54.120 | return from earnings and dividends.

01:21:56.280 | And you can see here, so I'm going to get very high.

01:21:58.880 | That would be 2007 up there.

01:22:00.680 | So I'm going to get very low.

01:22:02.560 | That would be 2009.

01:22:06.800 | And you can see the big bumps in the market, 1975 back there.

01:22:11.880 | And once you get way high, and that's 10%, the market return is 10% above the fundamental,

01:22:18.840 | it's going to come back.

01:22:20.200 | This is a chart that just screams out market returns revert to fundamental returns over

01:22:27.480 | time.

01:22:28.760 | So you can't worry about all those highs and lows in this chart, you've just got to worry

01:22:32.880 | about what the corporations of America and the world do for us.

01:22:37.280 | So as we look ahead, how does this get us?

01:22:40.480 | I don't have very good news for you here.

01:22:42.840 | The return over the last 55, 65 years has been 11% in the stock market, you knew that.

01:22:51.560 | And investment costs take about 2% out of that, leaving you with a net return of 9,

01:22:56.160 | I don't know what that 7 is doing there, and the prospect of, I use 4%, 5% earnings growth,

01:23:05.520 | which is maybe hard to achieve, 2% dividend yield compared to 3.3% in history.

01:23:12.000 | So if it's 3.3%, you've got to build into the record, and the yield is now 2%, that

01:23:17.560 | is a 1.3% dead weight loss in future returns.

01:23:22.680 | I don't know why people don't understand that.

01:23:24.920 | When I look at the P/E, the speculative return, this is speculative in both ways.

01:23:29.880 | And I've assumed here the market's fully valued now, not grossly overvalued, but it's selling

01:23:35.680 | about 23 times.

01:23:36.680 | If we're to go down to its long-term norm, 17 times, it would take 3% a year off that

01:23:42.960 | 4% a year, off that 7% a year investment return, getting you to 4.

01:23:48.480 | I can't tell you it would be 4, it could be better, it could be worse, that's probably

01:23:51.840 | a kind of a low number, but I think looking at a low number is not a bad idea when you're

01:23:57.400 | saving because if the catastrophe comes, and you assume the return would be too low, you'll

01:24:03.200 | have more money than you ever expected, so that can't hurt you.

01:24:07.160 | Having less money than you ever expected is pretty tough, so I think it's wise to use

01:24:10.720 | a conservative viewpoint in the future.

01:24:13.760 | And then look at those mutual fund costs.

01:24:16.580 | Those costs take you from 4% for the active fund to 2%.

01:24:22.400 | And the index fund, of course, the gross return will be the same as the active fund, and you

01:24:26.220 | only take 0.05 out of it for an Admiral Share and S&P 500, Vanguard S&P 500, and you get

01:24:32.720 | nearly 4%, nearly double the return over the next 10 years, just by getting costs out of

01:24:38.400 | the equation.

01:24:39.400 | And the lower the returns are, the higher the burden of costs.

01:24:47.060 | And so people just have to pay attention to costs more than ever if we look ahead and

01:24:53.460 | get this 4 or 5 or 6%, whatever it turns out to be, a market return.

01:24:58.680 | So not so good for stocks.

01:24:59.880 | How about bonds?

01:25:01.560 | Ooh, ouch.

01:25:02.960 | The average 10-year U.S. Treasury, that's the normal standard for the risk-free rate

01:25:10.160 | over this last 65 years, has been 5.7%.

01:25:14.120 | Today, it is 1.6%.

01:25:18.920 | I've added on a point in each case, because I don't think you need to stay with a 10-year

01:25:23.640 | Treasury.

01:25:24.640 | I think it's too conservative, too short, and too entirely government, you know, super

01:25:29.240 | safe.

01:25:30.240 | So if you take a moderate additional credit risk and a significant interest rate risk

01:25:35.240 | versus that Treasury 10-year note, you're going to get a risk-to-return on a bond portfolio

01:25:40.040 | of around 2.6% compared to 6.7% in the past.

01:25:44.760 | That seems like a big drop, but it's smaller than you would think, because real returns

01:25:50.540 | on bonds, that is, the bond return minus the cost of living, CPI, has dropped so much.

01:25:57.760 | Right now, we're looking at maybe 2% inflation, it could even be 1% ahead, and the past inflation

01:26:03.600 | was 3.6.

01:26:04.600 | So the real return was 2.1% in that historical period, not 5.7, which is the nominal return.

01:26:12.400 | And the Treasury portfolio of present return, 2%, would have a nominal return of 1.6, and

01:26:23.240 | a real return of 2.0%, but minus 0.4, and you'd be at 1.6% for the next 10 years.

01:26:38.080 | Too bad.

01:26:40.640 | So how does this look in a balanced portfolio?

01:26:42.800 | I'm getting to the end of this thing.

01:26:44.200 | I thought I said 48 slides, and I'm 52, so I think I made a mistake somewhere.

01:26:49.280 | But for the balanced portfolio, just using those numbers, the 50-year norm of returns

01:26:54.920 | on the markets, returns on the bond and stock markets, has been 50/50 portfolio.

01:27:01.160 | It's been 8.75% on the nominal return, 5.15.

01:27:06.640 | Looking ahead, the nominal return looks like around 3.3%, using those numbers that I've

01:27:12.240 | given you for stocks and bonds, 50/50, and 1.3% real.

01:27:19.040 | That's before the bond industry gets its hands on your money.

01:27:25.120 | The active funds are going to cost 1.5%, think about what that does to a real return of 1.3%,

01:27:34.280 | and that's counting trading costs and expense ratios.

01:27:37.400 | Or you have your choice.

01:27:38.400 | You can buy an index fund, which costs not 1.5, but 0.05, so it makes a big difference

01:27:45.480 | indexing, it'll make a big difference to you.

01:27:47.640 | And don't forget, also, that active funds have extra tax costs, they realize capital

01:27:54.680 | gains with remarkable frequency, and you've got to pay taxes on them, at least in your

01:27:58.600 | non-retirement accounts.

01:28:00.440 | And then investor behavior.

01:28:02.080 | And Morningstar will tell you, if a fund has a return of, let me say, 10% a year, the average

01:28:07.700 | investor in that fund will earn 8.5% a year, because we investors are pretty stupid as

01:28:13.400 | a group, we buy in a fund that's doing very hot, and when it does hot, it's going to do

01:28:19.440 | cold, and when it gets cold, we leave.

01:28:21.760 | So the fund return is almost inevitably, for any fund you've heard of, the funds that don't

01:28:26.080 | have much capital flow, don't have to face this problem.

01:28:29.040 | But for most funds, you're going to lose 1.5%.

01:28:32.880 | That does not happen in index funds, because it's never so good or so bad to draw money.

01:28:38.600 | Index fund is floating on an idea of capturing the market return, owning the market at less

01:28:45.880 | cost.

01:28:46.880 | And that's all there is to it.

01:28:47.880 | That's not to say, I don't worry about these huge cash flows that are coming into our index

01:28:53.280 | funds.

01:28:54.360 | And that's why I repeat whenever I can, we promise you your fair share of the market

01:28:58.680 | return, as I did in the video.

01:29:01.480 | Don't forget that you will get your fair share when the market goes down, too.

01:29:04.880 | If the market goes down 20%, you're going to lose 20%.

01:29:07.720 | There's no way around that.

01:29:09.640 | So it's still the best deal in town, as we'll talk about.

01:29:15.800 | It's going to change the way people invest for a whole lot of reasons.

01:29:21.040 | So to wrap up here, the bad news is, lower expected returns in history would suggest--

01:29:26.640 | I'm not saying I'm right in any of these numbers, to be very clear on that-- but I'm telling

01:29:30.280 | you what my reasonable expectations are for future returns.

01:29:36.920 | These are not predictions.

01:29:38.040 | Over a decade, implications, investors will have to save more.

01:29:42.000 | Low cost, more important to ever say the obvious.

01:29:44.840 | And the domination of index funds will continue and, I think, accelerate.

01:29:48.360 | The Department of Labor Petitiary Rule is going to favor low cost and index funds, particularly

01:29:53.840 | in retirement accounts.

01:29:55.720 | And a greater recognition of the past is not prologue.

01:29:58.480 | I showed you that number shown, quartiles.

01:30:01.160 | The past is, in a way, anti-prologue.

01:30:03.520 | It will develop a realistic skepticism about fund managers' consistency, because the more

01:30:11.020 | aggressive the manager is, the less consistency the return will show.

01:30:15.320 | And then, as that fundamental returns versus market returns chart showed you, that 10-year

01:30:20.360 | chart, reversion to the mean, RTM, will become part of the dialogue.

01:30:24.680 | That's what funds do.

01:30:25.680 | They revert to the market mean, or worse, and that's what I see in the future.

01:30:32.880 | Let me close by two quotes from Boglehead's 14XIV.

01:30:39.640 | And number one, which is going to really shape the industry, it's happening right now, the

01:30:43.600 | Supreme Court has taken a really tough look at mutual fund costs.

01:30:49.160 | In this hearing, Tibble versus Edison, unanimous ruling of the Supreme Court reaffirming fiduciary

01:30:55.480 | duty for retirement plan, defense lawyer, "It can't be the case that companies have

01:31:00.720 | to consistently look and scour the market for cheaper investment options for retirement

01:31:05.360 | plan options," the lawyer said.

01:31:08.080 | Justice Kennedy responds, "Well, you certainly do, if that's what a prudent trustee would

01:31:13.400 | do."

01:31:14.400 | I mean, that's the death knell for high-cost funds right there.

01:31:17.800 | Retirement plan area is a hugely important part, probably half of all mutual fund assets,

01:31:22.080 | so that will take its toll.

01:31:24.200 | And then finally, back to the old basics that I use time and time again, you can do worse

01:31:29.720 | than go back to Adam Smith, 1776.

01:31:33.240 | And what he tells us there is the interest of the producer ought to be attended to only

01:31:38.920 | so far as it may be necessary for promoting that of the consumer.

01:31:43.680 | The maximum is so perfectly self-evident, it would be absurd to attempt to prove it.

01:31:49.200 | The interest of the consumer must be the ultimate end and object of all industry and commerce.

01:31:59.080 | Turning that into investment language, the fund interest of fund shareholders, the consumers,

01:32:04.680 | must finally triumph over the interest of fund managers, producers, if you will.

01:32:11.320 | And that's the way this industry is going to grow.

01:32:13.800 | That's the way people have come to view the industry.

01:32:17.680 | Are they getting their fair share?

01:32:19.540 | And any fund manager that's not putting the interest of the fund shareholder over the

01:32:24.080 | interest of the fund manager is going to have a very, very tough time getting on the moon.

01:32:30.160 | Very tough.

01:32:31.160 | And a lot of them will go out of business.

01:32:32.160 | There will be a lot of change.

01:32:34.080 | And so before we get to the last slide, just let me say that these verities, this particular

01:32:43.400 | verity, that the consumer must be put first, means that even if the fiduciary duty to rule,

01:32:50.960 | which applies only to clients and retirement plans, even if that never develops further,

01:32:56.400 | and I believe it should develop a lot further and even cover the people that are running

01:32:59.960 | all that money, 70% of the market's cap, that's probably $18 or $19 trillion, ought to also

01:33:06.440 | be held to a fiduciary duty standard.

01:33:09.920 | Indeed, I would, in my tough way, say if you touch a penny of other people's money, you

01:33:16.280 | are a fiduciary and you've got to put the shareholder's interest first.

01:33:20.280 | That's the end game.

01:33:21.720 | Thank you.

01:33:22.720 | [Applause]

01:33:22.720 | >> Thank you.

01:33:23.720 | [Applause]

01:33:24.720 | >> Thank you.

01:33:25.720 | [Applause]

01:33:25.720 | >> Thank you.

01:33:31.720 | [Applause]

01:33:32.720 | >> Thank you.

01:33:32.720 | [Applause]

01:33:33.720 | >> Thank you.

01:33:33.720 | [Applause]

01:33:34.720 | >> Thank you.

01:33:34.720 | [Applause]

01:33:35.720 | >> Thank you.

01:33:36.720 | [Applause]

01:33:36.720 | >> Thank you.

01:33:37.720 | [Applause]

01:33:37.720 | >> Thank you.

01:33:38.720 | [Applause]

01:33:39.720 | >> Thank you.

01:33:40.720 | [Applause]

01:33:40.720 | you

01:33:42.780 | [BLANK_AUDIO]

Bogleheads® Conference 2016 - John Bogle Keynote

Chapters