Jack Bogle & Tom Gardner - Vanguard's Start, Index Funds & Fiduciary Duty

Bogle on Vanguard's 1974 start: 'We were hemorrhaging. We had more money going out than coming in for 83 months!' In the 'modern age' we'd call it disruptive technology. One director asked if Bogle realized they were hemorrhaging - 'Realize it? You've got to be kind of blind, you've got to be kind of stupid, and you've got to think it's great news when a month's cash flow goes from $20 million out to $19 million out.' The entire industry condemned index funds. Ned Johnson at Fidelity: 'Our shareholders would never want a fund with average performance.' Irony: 1976 when he said that, all Fidelity funds 'had fallen out of bed, weren't getting anything like average performance.' Now Fidelity has $150 billion index fund business.

Bogle on alternative indexing: 'Will a value-weighted index do better? Probably it will do better some of the time. I do not believe it will do better in the long run.' Fundamental indexing still owns essentially all S&P 500 stocks with 'somewhat different weights.' Problem: 'If they continue to do better, what will happen? Everybody will take their money out of the market-weighted index and put it into the value-weighted index, and then the opportunity will vanish. That's the way the markets work.' His conclusion: 'Should I give that certainty of relative return up for the uncertainty of whether one of these schemes will work? I know what I can get. I can do better than my neighbors. I can own the whole market.' Lab results seldom reflect real world.

Gardner asks how many funds someone needs. Bogle: 'You can certainly do it with one, and that would be something like the Vanguard Balanced Index Fund. It's 60% total stock market, 40% total bond market.' Three-step approach: pay off high-interest debt, save portion of salary, put it all in Balanced Index Fund - 'completely reasonable.' But nuances: younger should be 80-85% equities, older maybe 25% equities. Rule of thumb: 'bond position should equal your age.' Big gap in target-date funds: they ignore that 85% of shareholders have Social Security. Social Security capitalized value around $350,000 - if you have $350,000 in equity index, 'you're 50/50' but don't realize it. Should 'stop looking at the silly stock market every day and look at the cash flow.'

Bogle's devastating critique: '40 of the 50 largest fund groups are publicly held, and 30 of them by financial conglomerates. Think about buying a fund run by a financial conglomerate. Why did they buy their way into this industry? The Golconda. They wanted to jump on the wealth bandwagon of managing money, and they will accomplish that whether by hook or by crook.' If their return capital threshold is 15% and they pay $1 billion for a mutual fund company, 'they're going to have to take out $150 million a year - and it's easy. There's all kinds of things you can do to make it up.' The financial conglomerates 'basically tried to destroy this industry.'

Gardner's killer anecdote: Three former Merrill brokers at book signing said 'We now manage money. We've left the firm... We couldn't sell the index fund to our clients because we couldn't make any money on it, but we all owned it ourselves.' Gardner: 'It's the complete reversal of the fiduciary. It's like "I will be fiduciary for myself," and then fiduciary with my relationship with you is "If you're willing to buy what I'm selling, then I haven't done anything I should feel badly about."' Reality: fee-only fiduciary lives lean existence, VP at big firm has country house making $1 million/year selling load funds and 'booby traps to keep you locked into different products.'

Bogle: 'The investment business is really a business of mathematical candor. You can't hide.' If you're selling a Mercedes, salesman talks about neighbors being envious, door slamming nicely. 'But in the financial business, value is one thing: Dollars. It can be measured, unlike all these esoteric things that characterize capitalism.' Getting market return in index fund vs. paying 2% for managed fund means 'you get about $0.30 on the dollar. $0.30. But you've got to look at 40 or 50 years.' For 25-year-olds: '50 years is 75. That's too short! They'll live to 95. They should be looking at 70 years, and these numbers just get further and further apart.' Many need help but 'we have to rethink how we pay for that help. 1% may be much too high.'

Bogle explains Vanguard philosophy: After closing Windsor Fund in 1985 (too big), started Windsor II. Everyone said it would never do as well - 'it's done better, a little.' For U.S. Growth, needed new manager so 'I did what set the standard: bring in another manager, and then another manager, and then another.' Most equity funds have 5-7 managers. 'If you're comparing with universe of large-cap value funds and there are 50 funds in that universe, five is going to have the same return. It's a law of large numbers thing. There's not much premium on manager selection.' They win by 1.5% annually 'not because we pick better managers, but because we have very low operating costs' and negotiate fees down. 'If we're good enough to be average - or lucky enough to be average - we win by 1.5% a year, which is 20% over 10 years.'

Gardner asks if there's ever a situation to own load fund. Bogle: 'I'd say unequivocally not.' The advisor will show you a load fund that beat the index even with 5% commission. 'Well, hindsight is always 20/20. If they can't find a fund that beat the index, they can't be very acute. It's the easiest thing in the world to do! But don't believe it. The past is not prologue, and actually if you look at the numbers carefully enough and long enough, you'll see the past performance of the fund is anti-prologue. The better it is in the past, the more the regression to the mean; the greater that's going to be in the future.'

Bogle on fiduciary debate: 'The issue is very narrow at the moment... the fiduciary standard for people who are selling funds - investment advisors, stockbrokers... the firing line level. I think we are making a very big mistake. I've written to the SEC three times about this: the biggest problem on the fiduciary side is in the fund manager side. We need a federal standard of fiduciary duty for fund managers.' The debate focuses on advisors but misses the bigger problem upstream.

Bogle on health challenges: Six heart attacks and heart transplant, 'you go into them optimistically. My wife is a powerful support, my kids are wonderful. You get over the bumps. You're always optimistic.' Hospital attitude: 'They put you down on the gurney and you just go "Here we go again."' His pragmatism: 'If I thought jumping up and down on the kitchen table and screaming about the unfairness of life would help my condition, I would do it! But it occurs to me it would make it even worse.' Still writing: Journal of Portfolio Management article, Financial Analysts Journal article, forewords on Paul Cabot and John Maynard Keynes books, 'I've got Keynes, Adam Smith, industry founders, two academic articles, and I'm starting to worry I'm going to run out of things to do.'