John Bogle Joins The Revolution

John C. Bogle is founder of The Vanguard Group, Inc., and president of the Bogle Financial Markets Research Center. He is the author of several books, including his latest, The Battle for the Soul of Capitalism, scheduled for release in November. He joined our radio program, “The Investing Revolution,” on September 16 to discuss the ideas in his new book. The following is a portion of that interview.

Jim Whiddon: Mr. Bogle, you started the first index fund back in 1974 and since then The Vanguard Group and their investors have experienced some incredible success in that passive type of investing. Here we are 30 years later and the passive low-cost investing is still only a tiny part of the mutual fund business. Why has the industry taken so long to catch on?

John Bogle: Why doesn’t it get out there? Because the fund business is based on selling something to somebody and it’s easier to sell an actively managed fund because you can always find an actively managed fund that is shooting the lights out. If people would only understand that the past is not a prologue to the future, they would be much more successful investors. It’s really quite as simple as that.

Lance Alston: The title of your book is intriguing to me, The Battle for the Soul of Capitalism. On the cover there is a quote, “How the financial system undermined social ideals, damaged trust in the markets, robbed investors of trillions and what to do about it.” Let’s start with the past. What has gone wrong with the financial system since you started Vanguard 30 years ago?

JB: Well, we have a taken a wonderful system of capitalism in which rewards went to the owners (those who put up the capital and took the risk) and moved to a system of managers’ capitalism. I call it in the book a pathological mutation from owners’ to managers’ capitalism, where far too much of the reward is going to the managers and far too little, therefore, going to the owners.

You see this in CEO compensation. Where the CEO 25 years ago was making maybe 40 times the salary of the average worker, it’s been as high as 500 times. And people say, “They should get that kind of money if they do a good job.” Well, the fact of the matter is, these CEOs as a group have predicted over the last 25 years that their earnings would grow at 11.5% per year. They’ve delivered 6% a year and the economy’s been growing at 6.5%. Does that sound like good performance, to fall halfway short of your expectations and half a point behind simply being in the economy? Not at all.

LA: Now in the financial services industry, we’ve seen a lot of consolidation. Is this exacerbating the problems of the management incentive?

JB: It really is, because the big incentive is, of course, to get big. Mutual fund managers don’t make a lot of money when they perform well. They make a lot of money when they run a lot of assets and, as the inestimable Warren Buffett says, “A fat wallet is the enemy of superior returns.” The bigger you get, the harder it is to deliver the results that people looked at in your early years and want to get again. It doesn’t come back. You can’t go back again once you get to this giant size. And this is an industry of huge companies: $50 billion, $100 billion, $500 billion in assets managed. There are two firms that are managing $1 trillion of assets. How can they differentiate themselves when the US stock market’s around $13 trillion and here they are managing $1 trillion of those dollars? They cannot do well at that level.

The Fidelity Magellan fund is a classic example of that. It was great, it got big, it stopped being great and in the last 10 years they’ve lagged the market by around 2 percentage points a year, the amount of all their transaction and management fees and all those costs. In the meanwhile, they’ve paid Fidelity around $4 billion for below average returns. It’s a lot of money. A lot of money. For nothing.

LA: You talk in your speeches quite often about the word ‘fiduciary’ and that seems to be lacking in the relationship that most investors have with mutual fund companies. Can we get back to the point where there is a fiduciary relationship between investors and the people who invest their money?

JB: [We need] a federal statute of fiduciary duty. We do not have that now. We have state statutes [and] they’re loosely enforced and will never be enforced because state regulation is a little like a race to the bottom. [If one state has] tough fiduciary standards, corporations or mutual funds will move to a state that has easy ones. So there’s not a lot of market discipline in bringing fiduciary duty. The SEC is trying to do it by having an independent mutual fund chairman, independent of the management company. Managers have been known to appraise bad results with rose-colored glasses on. As you can probably imagine, they can’t be objective. So [that’s an] important step. [It’s] being fought tooth and nail by the Investment Company Institute and by the US Chamber of Commerce because they don’t want mutual funds to be controlled by their own investors. I hope the courts will see through all that double talk and allow these very important reforms to go through. We need the federal statute of fiduciary duty. That’s one of the policy recommendations in the book.

JW: We’ve talked about the past and the present; let’s finish the cycle by talking about the future. You’ve mentioned that it cannot last, it cannot stand. We make you king for a day. What one thing would you hone in on if you could change some things in the financial services industry?

JB: Wake Up Investors. If investors could [only] understand, clearly, what I’m talking to you about today. [If they] could realize that all this trading, moving in and out, all this expense is a deadweight on their return and a devastating weight over a lifetime. If they were merely educated enough to know we have a failed system, a policing machine, a skimming machine, a giant scam (these are some of the words that responsible people have called the mutual fund industry). If they would realize that and understand the relentless rules of humble arithmetic, they would move their money only to people who are recognizing their fiduciary duty and giving them a fair shake.

JW: The book is called The Battle for the Soul of Capitalism, available at most bookstores very soon and of course online. Mr. Bogle, we can’t thank you enough for joining us here on “The Investing Revolution.”

JB: Great to be with you and good luck to you, too, and also to all of your listeners.

 Contact Us  /  Home

Click here to read excerpts from Wealth Without Worry

©2007 JWA Financial Group, Inc. All rights reserved