A Visit with John Bogle

At 80, he says he doesn’t get enough done. And while ever more money is moved around the world by legions of finance Ph.D.s, he offers this assessment of investing.

It’s not rocket science.”

Meet John Bogle. He’s the crusty founder and retired chairman of Vanguard, now the largest mutual fund firm in America, but I prefer to think of him as the Jedi knight of investing. And the force is with him.

I’ve called him to talk about the 10th anniversary edition of his classic book, “Common Sense on Mutual Funds” ($30, Wiley & Sons). Now 600 pages, up from 450 in the first edition, this is the definitive book on index fund investing. It explains why index fund investing is the best way— no, the only way— for people to invest their savings.

A zealot?

You bet. But he does something few in the investing world would dare to do. He stands by what he said 10 years ago. The original text is presented unchanged. New data is added to reveal what happened over the last ten years. Although the ‘90s and the ‘00s were diametric opposites for investing, the results still show that:

  • costs matter,
  • low-cost index funds are the surest way to achieve market returns,
  • and spending money to achieve high returns rarely works.

The difference over time, he points out, is enormous. In the 40-year period ending 2008, for instance, a $10,000 investment in a low-cost S&P 500 index fund would have grown to $346,117. During the same period, the average managed domestic equity fund found grew to $201,513. The difference is more than 14 times the original investment.

In a telephone interview, I asked Mr. Bogle what he thought was the biggest problem in investing. “It’s that people are focused on short-term performance. And there are always some funds that will beat an index. It’s the willingness to project the immediate past into the future,” he said.

Most people, he pointed out, fail to distinguish between what he calls “the fundamental return” from investments and “the speculative return.” If this distinction is new to you, here’s what it means. The fundamental return a corporation earns is its dividend yield and earnings growth. In today’s market, that would be about 2 percent for dividends and perhaps 6 percent for earnings growth, a total of 8 percent.

The speculative return is the change in value that comes from what investors will pay for a dollar of earnings. When people are pessimistic about the future, they will pay less for earnings. When they are optimistic, they will pay more. The speculative return nearly doubled the return on stocks in the ‘80s and ‘90s. But it reduced returns to a negative value in the ‘00s.

“But, over time, it’s all about the fundamental return. The speculative returns tend to cancel out,” he said. “Basically, the stock market is a giant distraction from the business of investing.”

I asked how he felt about the rising tide of international investing. “People forget that large U.S. companies have substantial revenue and profits from other countries. Today most large U.S. companies are diversified internationally, so you’re already an international investor when you buy the U.S. market,” he said.

“People chase performance. So they are leaving domestic stocks and going into international stocks at a rate that is frightening. I think you should limit international stocks to 20 percent of your equity exposure. Put half in developed markets and half in emerging markets. The clear proof is the difference between the return a fund earns and the investor return on the same fund. There are some really big gaps.”

The investor return depends on when the investor commits to a fund. These returns, now calculated by Morningstar, show that investors tend to buy after large increases in value and before large decreases in value. Basically, the “hot money” gets a lower return than the fund, and the managed fund, in turn, earns less than an index.

Mr. Bogle is particularly concerned about the rapid growth of exchange-traded funds (ETFs) because people are trading these funds like hot stocks. A recent report from Strategic Insight, a mutual fund research firm, provides some clear evidence. In all of 2009, only $6.3 billion of new money went into domestic equity funds. But $75.3 billion went into international equities. And a record $396.2 billion went into bonds.

The Ten Largest Fund Families

This list shows the largest fund groups ranked in order of their assets under management. In recent years both American Funds and Fidelity have topped the list. While Mr. Bogle may feel that he doesn’t get enough done, the list is a powerful indication that his call to low-cost investing has been heard by millions of investors. It’s also significant that most observers consider American Funds, Fidelity Investments, T. Rowe Price, and Dodge & Cox to be relatively low-cost fund firms. Mr. Bogle disagrees. He argues that all of those firms have plenty of room to lower their fees.

Fund Family Total Net Assets in $Billions Market Share in Percent
Vanguard $1,067 15.42%
American Funds 914 13.22
Fidelity Investments 738 10.67
PIMCO Funds 326 4.71
Franklin Templeton 283 4.10
T. Rowe Price 218 3.15
Oppenheimer Funds 123 1.78
Dodge & Cox 112 1.62
John Hancock 109 1.58
BlackRock 106 1.54

On the web:

Common Sense on Mutual Funds on Amazon (paper edition):

Common Sense on Mutual Funds on Amazon (Kindle edition)

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November 27, 2009: The Investors Manifesto

July 6, 2007: The Perils of Hyperactive Investing