Episode 133 – John Bogle, a Financial Industry Giant, Addresses Congress

Episode: 133
Originally Aired: July 9, 2015
Topic: John Bogle, a Financial Industry Giant, Addresses Congress

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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John Bogle, a Financial Industry Giant, Addresses Congress
James Lange, CPA/Attorney
Guest: John Bogle, Founder, Retired CEO of The Vanguard Group
Episode 133

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TOPICS COVERED:

1. Guest Introduction: John Bogle
2. Low Cost Index Funds
3. Advice to Employees Building Their Retirement Plan at Work
4. Advice to Employers
5. Social Security: Why Is It Broken and What Can Be Done to Fix It?
6. Defined Benefit (aka Pension) Plans
7. Problems with Defined Contribution Plans
8. Fiduciary Standard
9. Resources for Investors

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1. Guest Introduction: John Bogle

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m your host, David Bear, here in the studio with James Lange, CPA/Attorney and author of three best-selling books: Retire Secure!, The Roth Revolution: Pay Taxes Once and Never Again and most recently, Retire Secure! For Same-Sex Couples: Live Gay, Retire Rich.  Today, we welcome back a very special guest indeed, a man whom Fortune magazine named one of four industry investment giants of the twentieth century.  John C. Bogle is the founder and now retired CEO of the Vanguard Group, the world’s largest mutual fund company, managing more than three trillion dollars.  It’s safe to say that over the course of his 63-year career, Mr. Bogle has changed the face of investing.  A pioneer in the concept of index mutual funds, collective portfolios of stock that mimic movement of a defined market sector rather than individual companies, he’s credited with creating the first index fund available to individual investors, the Vanguard 500.  Mr. Bogle’s written a dozen books, from his 1994 classic, Bogle on Mutual Funds, to, most recently, The Clash of the Cultures: Investment vs. Speculation.  At 85, he remains an active industry observer, appearing regularly on national financial media outlets.  He recently described a mission he set himself: to speak out for truth and integrity and character in the world of finance, striving to build a better world for investors, honest-to-God, down to earth human beings, who deserve a fair shake.  We’re honored to have him back as a guest on The Lange Money Hour, so please stay tuned for an interesting and informative hour.  And with that, I’ll say hello, Jim and welcome, Mr. Bogle.

Jim Lange:  Welcome, Mr. Bogle!

John Bogle:  My pleasure to be with you.

Jim Lange:  I want to start again by thanking you for appearing on The Lange Money Hour.  The last time you were on, our listeners heard great insights about some of the problems with our economy and problems with the gatekeepers so articulately discussed in your book, The Clash of Cultures, which I still recommend to our listeners.  By the way, that’s The Clash of Cultures: Investment vs. Speculation by John C. Bogle.  On September 16th of this year, you testified before the Senate Finance Committee, and I was hoping that we could go a little bit further in depth of some of the things that you talked about.  Would that be okay with you?

John Bogle:  That’s fine.  Give me a little extra time.  You’re always limited when you’re before the Senate Finance Committee, so that’s good.

Jim Lange:  All right, well, we have close to an hour.

David Bear:  And you had six minutes there, so…

2. Low Cost Index Funds

Jim Lange:  It seemed that one of your themes was, a lot of investors were being hurt by paying high fees charged by active money managers.  Your idea of low-cost index funds that you implemented with Vanguard in 1974 has exploded, with the Vanguard S&P consisting of $1.7 trillion.  And that doesn’t include other index funds, either inside or outside Vanguard.  Why should investors utilize low-cost index funds for their investments?

John Bogle:  Well, let me just slightly correct the math.  We’re now at $3 trillion in total, and, of that, about $2 trillion is invested in index funds of one kind or another, with about a trillion-two of that, trillion-three, being in the S&P 500 index fund, the original index fund, and about an equal amount in our Vanguard total stock market index fund, which is the S&P index plus the rest of the market, large and mid-cap and small cap funds.  So, we’re basically, fundamentally, an index business with 70% of our assets in index funds.

What do index funds bring to the table?  Why should investors use them?  Well, because they work, when you think about it!  And just think about it in this way: all of us investors together own the total stock market.  And if you visualize a piece of pie, about 30% of that pie is index funds themselves, held by institutions and individuals.  That leaves 70% in the total stock market, which owns the exact same stocks, but just in larger amounts.  So, that 70% is basically, they’re all indexed as a group.  But individually, they trade back and forth with each other and hope that they are smarter or luckier than other investors.  And to make matters worse, they pay people a lot of money.  Money managers get paid out of that amount of assets.  Stock brokers, investment bankers, marketers, all those things come out of the 70% of group indexing, if you will.  So, those index fund investors in the aggregate lose to the market by the amount of the return that is consumed by costs.  And in the mutual fund industry, that number is often one percent, but that’s just the expense ratio.  And when you look at other costs, for example, the turnover cost wants to turnover their portfolios at a ferocious rate, and it’s not free.  Investors pay sales loads.  They’re paying investment advisors.  That’s not free.

So, I estimate in an article in a recent issue of the Financial Analysts Journal that those other costs are around two-and-a-quarter percent a year.  So now, look back at that pie.  You’ve got 30% of the investors owning the indexes and paying, maybe 0.5 of one percent, meaning in a 7% market, they’re in 6.95%.  And the other investors, who are collective indexers, get the same 7% return, but they pay two-and-a-quarter percent per year.  So, it turns out that they earned not 6.95%, but 4.75% a year.  And over time, as you compound, that means that the investor who invests for the long-term is getting about 30% of the cumulative market return.  You know, just take a look.  Your listeners can take a look at a compound interest table and take a look at, say, 7% versus 5% (to make the math easy) over a fifty-year investment lifetime, and the difference is dramatic, and investors give up about two-thirds of their return or more to the financial system and get only one-third for themselves.  So, that’s why investors should utilize low-cost index for their investment.

Jim Lange:  But isn’t there an argument that some money managers, maybe Warren Buffett for example, have beat the index over time?  And why not research the mutual funds and money managers that have beat the index, even over and above costs, and invest with them?

John Bogle:  Well, first, let me say, I’m a great admirer of Warren Buffett, and he is a great admirer of the index fund, and a great admirer of mine, if you will, and indeed, as we read recently in the press, he has taken the ultimate step.  He’s leaving his wife a substantial inheritance, and he has directed that 90% of that inheritance be put into Vanguard S&P 500 index fund.

David Bear:  Quite an endorsement!

John Bogle:  Yes!  He’s a good manager, and he still believes in indexing.  Warren is not in the mutual fund business.  He’s his own man.  He does what we wants.  He doesn’t have to worry about money coming in and out of a fund, coming in when times are good and stocks are high, and going out when times are bad, performance is bad, and stocks are low.  So, he has a wonderful record, but he hasn’t had to deal with the pressures that mutual fund managers have.  These managers come and go.  The average mutual fund manager runs the fund for seven years.  Just put that in the context of your fifty-year, give or take, investment horizon, and the average fund, about half of the mutual funds, in a given decade, go out of business.  So, picking a mutual fund is not an easy thing, and of course, the ones that survive are the ones that we look at as successful without realizing there’s so many failures out there.  And we also know beyond any doubt that even the most successful mutual fund managers — Peter Lynch of Magellan, Bill Miller of Legg Mason, and a few others who have had sensational records –after a time, have bad luck, bad fortune, and are getting old, God knows what, but they revert from being way above average to being way below average.  It happens in every large fund in the industry.  We looked at these large funds, successful funds, T. Rowe Price growth, our own Windsor Fund, they do well for a time, and then they revert to the average.  There’s no way around that.  The past is not prologue.  So, do not, under any circumstances, believe because you pick a fund managed by somebody who has beaten the index, that that beating will continue, that they will continue to be superior.  It simply, on the record, does not happen.

3. Advice to Employees Building Their Retirement Plan at Work

Jim Lange:  Well, I’ve heard you say that before that the performance does revert to the mean, and apparently, that’s a perfect example.  So, let’s say that you are an employee, and you are trying to utilize the best advice, which is to take advantage of your employer retirement plan at work, either through a Roth 401(k), or even a traditional 401(k), or, if you’re in the public sector, a 403(b) or a Roth 403(b), what advice would you have for employees trying to build their retirement plan for their future?

John Bogle:  Well, I’d start with the simplest advice of all, and that is put all the pressure you can on your employer to give you a list of mutual funds from which to choose that are sound investments for a lifetime.  And that means, ultimately, index funds.  A set of index funds, their portfolio managers never change.  They have no portfolio manager because it doesn’t require any management at the beginning of the life cycle, and they continue to have no portfolio manager throughout the life cycle, and at the end of your life cycle, they still have no portfolio manager.  It’s kind of counterintuitive, but it means you don’t have to worry about jumping on the bandwagon for a good record.  And if you don’t do index funds (which I strongly recommend to most people), see if you can find some good low-cost funds run by responsible organizations that are involved in the profession of money management, and not the business of mutual fund marketing.  Avoid funds that are heavily marketed, avoid funds that are expensive, and avoid funds with high rates of portfolio turnover because I would suggest that there’s a lot of money you waste going back and forth from one stock to another, and try and find, if you will, mutual funds that closely resemble index funds.  But if you’re going to do that, you might as well go the whole way guys!  You might as well go the whole way and do the index fund.

4. Advice to Employers

Jim Lange:  And the natural joinder to that is what advice would you have for employers who are considering what type of investments to offer their employees?

John Bogle:  Well, they just have to have a more broad gauged approach.  The index funds are getting more and more important in the retirement-defined contribution 401(k) area, and in fact, Vanguard has, as I understand, the largest amount of 401(k) and other defined contribution assets, IRAs and so on, of any fund group in the industry.  So, we’re very important out there, and I want to be clear on this: it’s not a Vanguard issue.  If responsible fund organizations have good index funds at low prices, they’re perfectly acceptable.  I don’t want this to be a commercial about Vanguard.  I want it to be a commercial, if you will, about the sound idea of owning the stock market and holding it forever at low cost, and that’s what indexing is.

5. Social Security:  Why Is It Broken and What Can Be Done to Fix It?

Jim Lange:  Well, speaking of building a portfolio for retirement, in your testimony, you mentioned that there are three legs of our retirement stool, and that all three legs are shaky.  The first one is Social Security, which you said is broken.  First, why is it broken, and what can be done to fix it?

John Bogle:  Well, the reason it’s broken today, the system is fine, but it’s not actuarially sound.  And that is to say, stating it simply, that we’ve let benefits grow much faster than we’ve had contributions grow, contributions from employees.  And, you know, I think most of the statisticians are going to tell you by about 2023 or 2025, Social Security will no longer be able to provide the present benefits.  They’re not going to go out of business because it’s a large plan, but they will only be able to provide, I think it’s an estimated 70% of today’s benefits.  That’s not bad, not awful, but it’s not good enough.  So, what we have to do is fix it in some pretty easy ways because it’s a very long-term program.  And one way is to maybe increase the maximum Social Security wage base.  Now, we’re around $115,000.  And if you raise that to $150,000, say, you’ll get a lot more contributions coming in.  The people on the higher end of the scale that are making more money than $115,000 are going to complain about it, but maybe it’s time they do their share.  We also have had two generous cost of living adjustment formulas.  The great thing about Social Security (it’s an unbelievably good plan overall) is that it basically has a cost of living adjustment.  It keeps up with the cost of living, and the payments go up pretty much year after year, payments to retirees, or at least payments to people that are, like me, over seventy but haven’t retired yet.  And so, we can kind of deal with that, but instead of using a cost of living wage base that goes up roughly in accordance with the wages of America, that’s too fast, we should have it go up with the cost of living itself rather than the rate of wage basis.  And you can do that.  You can make the retirement age 69 instead of 60, maybe 67, 68.  Now, a lot of employees, take a stonemason or something like that, can’t really work until he’s 69, or very rarely can, so we need some kind of an ability to have an earlier retirement age for those who cannot do their trade.  You know, most of us at desks and jobs like that can certainly work until 69.  Heck guys, I’m 85 and I’m still going like blazes!

David Bear:  Well, you’re a special case!

John Bogle:  So, bad cases make bad laws, I don’t know!  There are a lot of very small adjustments that can be made and will be made that will make it fiscally sound.  There’s no question about that.  Our political system is not going to let Social Security benefits beneficiaries down, in part, at least, other than an enlightened sense of self-interest, because they’ll be voted out of office if they do.

Jim Lange:  Well, can an investor rely on it?  So, let’s say somebody’s doing projections about their retirement and they’re saying, “Okay, according to the Social Security estimate, I’ll get, say, $25,000 or $30,000 a year.”  Is that something that they can rely on, or do you think that, no, they can only rely on, say, you used the number 70%?

John Bogle:  Well, let me say this: I profoundly believe that we will change the Social Security system’s mathematics in a way that makes the system financially viable for another 75 or 100 years.  That can be done fairly easily.  People actually, other than the political arguments, would hardly know it is being done.  A change in the cost of living adjustment that goes out into the future, you know, nobody’s going to know that.  And it’s not that it should be hidden, it should be spelled out and disclosed.  But you can get $30,000 or $40,000 or even, I think the maximum you can get now, with a spouse and a husband who doesn’t take payments until age 70, can be as much as $50,000 a year.  And so, you have a very, very good investment in Social Security, and I believe profoundly that the system will not collapse.  It will respond and be fixed with fairly simple, but long-term actuarially difficult to even notice changes.

David Bear:  Let’s take a quick break.

BREAK ONE

David Bear:  And welcome back to this edition of The Lange Money Hour.  I’m David Bear here with Jim Lange and John C. Bogle.

6. Defined Benefit (aka Pension) Plans

Jim Lange:  Mr. Bogle, could we talk about defined benefit plans, also known as pension plans?  In your testimony to Congress, you said that they were underwater by four trillion dollars.  What do you mean by ‘they are underwater?’

John Bogle:  Well, first of all, that answer is not entirely adequate.  We have two kinds of defined benefit plans, one of which continues to grow.  That would be plans for public employees, government employees and the like, small government, state and local government and so on.  And they have a deficit of about $4 trillion themselves.  That’s just one type of defined benefit plan.  What does that mean?  It means to measure up to their actuarial obligations, they may need (let me say for the purpose of argument) $25 trillion, but they’ve only got $21 trillion by actual asset value.  So, they’re falling short.  They’re underfunded.  They’re underwater in terms of the obligations they’ve accepted for their retirees.  And the same situation (although not quite as bad) applies to defined benefit plans, pension plans, of corporations.  And they’re also underwater.  I think the generally accepted number is about $800 billion, and that means the market value of their assets are insufficient by that amount to support their liabilities for future payments.  So, they’re in trouble.

To make matters worse, these defined benefit plans are looking into the future and seeing what kind of earnings they can have if they’re in a bad situation, and what kind of earnings will they have on their plan, let’s say, in the next decade.  And most public and private plans are assuming a 7.5% or an 8% return on their assets.  Well, look, today, the yield on bonds, which is probably 60% at least of all those portfolios, is 3%, nowhere near 8%.  And as I look at the future for stocks, it’s not going to be as good as the past because dividend yields are so low, and earnings growth may be a little lower, but maybe stocks will produce 7% if we’re lucky.  You put together a portfolio of stocks and bonds, and you may come out to 4.5% after the cost of investing.  Well, 4.5% is not 8%.  So, they’re going to have to step up the funding.  They’re committed to these future payments to beneficiaries, and if they can’t make them, they’ll go on to the Pension Benefit Guarantee Corporation of the U.S. government, but that itself is on the edge of bankruptcy, in terms of having more obligations.  So, the defined benefit pension plan system is deeply troubled, and the remedies to fix those problems are not the relatively easy, almost unnoticed, solution to Social Security, but the most painful kinds of solutions you could have.  Defined benefit plans either have to have more contributions from the corporations and the municipalities (and the corporations don’t like to do that, it hurts their earnings when they put more money into the pension plan), or they have to have less benefits to their employees whether they’re covered by their government or not.  So, some of those payments in the public sector are actually guaranteed by, in some cases, I think, state constitutions.

Jim Lange:  Like Pennsylvania.

John Bogle:  So, they’re going to have trouble, the witnesses out in Detroit and Chicago, they’re going to have awful trouble living up to those obligations because the states do not have unlimited borrowing power.  To fix the problem, therefore, we have this painful, unpleasant, and only way to do it: increase contributions to the plans, whether public or private, and/or reduce the payment to the beneficiaries of the plan, either public sector or private sector.

Jim Lange:  Well, that does sound pretty unpleasant, but what about retired investors right now who have been promised whether you’re a, let’s say, school teacher on a public pension, or a retiree from a corporation, and you have, at least, expected a certain amount.  Is that something that you can rely on, or do you have to think of other ways to support your retirement?

John Bogle:  Well, first place, as a general rule, you cannot rely on it.  There are probably numerous specific corporations and specific municipalities who will pass that test.  But there are even more numerous corporations, I think, and certainly municipalities, state and local governments, which will not pass that test.  And there’s an old saying, you guys may know it, ‘You can’t get blood out of a turnip.’  So, if there are no resources to pay the benefits, the benefits will not be paid.  And the courts can demand they be paid, but if there’s no money, it’s not going to be paid.  So, we have to be fiscally sound, we have to eliminate this large gap between assets and liabilities today, and we’ve got to be prepared for future returns in the marketplace to be more like 5% than 8%.  It’s tough medicine.

7. Problems with Defined Contribution Plans

Jim Lange:  I think we’re hearing the wise words of the professor of harsh reality.  The third leg that you talked about in your testimony was the problem with defined contribution plans.  And for our listeners, a defined contribution plan would be a 401(k), a 403(b), a 457, the types of things that people call retirement plans.  And you already mentioned some of the huge problems with the traditional pension plans, and more and more companies and government agencies are changing to the defined benefit plans.  What are some of the problems that you have seen with these defined contribution plans?

John Bogle:  Okay, well, there are two problems with defined contribution plans, and don’t forget IRAs, Individual Retirement Accounts, because that’s the biggest sector of defined contribution plans, in large measure because when people retire and get their 401(k) proceeds still run by the company, they take them out and put them into a personal IRA.  So, it’s kind of a continuation of the 401(k) plan and the 403(b).  And so, that’s a big part of it, and you’re on your own.  But the problems are two: number one, we are not saving enough.  I tried to explain this to the Senate committee, and there were many people, including the Investment Company Institute and others, who said they were putting away plenty of money.  Well, look, the reality is that today, if you’re around retirement age, according to the Boston Center for Retirement Research from Boston College, the average balance of someone that age in their defined contribution plan is $120,000.  Well, if you earn 2%, let’s make it 4%.  You don’t earn 4%, but you might be able to withdraw 4% of capital.  That’s $4,800 a year, or $400 a month.  That’s not going to be the difference between success and failure.  So, you’re not saving enough.  The argument is that people are all well prepared, and somebody said that 80% of their retirees are doing fine, and I have to ask myself, since it’s an unalterable fact, if a third of our families have no retirement plan whatsoever, how can 80% be prepared for retirement?  I’ll leave that to the data crunchers!  But it’s not possible.  So, people are not saving enough, so savings rates have to go up.  People have to put more away.  And they have to assume lower future returns, just like the pension plans do.

In addition, and this is really my main theme (I’ll leave whether we’re in good shape or not to others to fix), to not saving enough, they aren’t earning their fair share of the market return on their investments.  These defined contribution plans, particularly in the IRA area, are very high cost, in general.  Vanguard, as you know, as I’d mentioned, is very large, and we’re paying very low cost.  They pay us very low cost.  But when you think about a lifetime of investing in a defined contribution plan, the difference between getting your fair share of the stock market’s return (let’s think just about stocks for a moment) and not is a staggering difference.  I did a study for the Financial Analysts Journal, and it showed that something like, if you invest in a typical mutual fund and, you know, you start with $30,000 and get a 3% increase a year and keep investing 10% of your compensation, if you invest in a standard, actively managed mutual fund, you’ll end up with around $550,000, I think, and if you do it in an index fund, because of its lower cost, you end up with almost $950,000.  That’s almost $400,000 more simply by making the right investment choices.  And this is not just me talking, this is Nobel Laureate William Sharpe, whose integrity and independence is totally unquestioned.  He’s not trying to sell anything.  And so, we have to have a lot of costs taken out of the system, and I would suggest that somehow, we should have an oversight of the retirement plan business allowing and saying…basically, you would have to gain entry into the system.  There would be some kind of agency that looked at you and said, “Yes, you’re qualified to be part of a 401(k), 403(b), IRA system,” or “You are not.”  And that’s going to mean that index funds will qualify.  Maybe index-like funds will qualify.  High cost funds, high turnover funds, would not qualify.  This is tough medicine.  People don’t like that kind of regulation.  But sooner or later, it’s not what we like in regulation, it is how do we give the average investor, the average human being who puts his money away, a fair shake?  That’s the issue.

Jim Lange:  Well, I think that you have talked about some more ideas regarding a fiduciary standard because I think that the index advisors would presumably have a fiduciary standard to try to work their best on behalf of their client.  First, for our listeners, could you tell our listeners what a fiduciary standard is?

8. Fiduciary Standard

John Bogle:  A fiduciary standard, going back centuries under English common law, is you put the interest of your trust beneficiary ahead of your own personal interest.  It’s serving the beneficiary rather than serving the trustee.  And in our business, it’s kind of messed up because everybody ought to know there are two sets of beneficiaries in this equation in the mutual fund industry today.  There are two masters to be served: one is the mutual fund shareholder.  Fund directors and officers have a fiduciary duty under the 840 Act, implicit, not explicit, to serve the interest of investors first and managers and distributors second.  So, that’s the beginning of it.  Unfortunately, of the fifty largest mutual fund managers, forty are either publicly held, or even more significantly, held by giant financial conglomerates.  And they have shareholders too!  And the directors of the management company have a fiduciary duty to those shareholders, like the directors of any corporation do.  So, they have two masters, and quoting Matthew in the holy Bible, “No man can serve two masters, or he will love the one and hate the other.”  And I’m afraid the master that gets loved in this business is the master who’s paying the bills, the management company and all its desire to build profits and pay the executives a lot of money.  And so, we have a bad system there and we need a federal standard of fiduciary duty that articulates ‘investor first.’  The awful thing about it, the mysterious thing about it, if I told the committee in my testimony (I didn’t get this into my opening statement), is both in the Dodd-Frank Act, Securities Reform Act, and the Department of Labor’s attempt to build fiduciary standards, they both say there ought to be a fiduciary standard for just about everybody except the money managers.  The money managers, in both cases, are specifically excluded.  Congress has said, “Talk about fiduciary duty all you want, but don’t talk about fiduciary duty and money managers.”  How could that happen?  How could that be the real world?  How could we let that go unnoticed?  Well, it’s a mystery to me, but I notice it.  Maybe because I notice everything!  But that has to be fixed.  We need, basically, another amendment to the Dodd-Frank Act saying “If you touch other people’s money, you are a fiduciary.  Period.”

Jim Lange:  Well, I think that’s terrific advice for the country, but what about the individual investor?  Because most financial advisors, stockbrokers, insurance agents, etc. are not fiduciary advisors.  Do you think it is incumbent upon the individual investor to make sure that they are working with a fiduciary advisor?

John Bogle:  Well, I do, and actually, under the Investment Advisors Act of 1940 (it came out the same time as the Investment Company or Mutual Fund Act of 1940), they do in fact have a fiduciary duty under the law.  It’s very clear.  So, a financial advisor has a fiduciary duty.  Whether it’s adequately observed is a wholly different question.  But the duty is there.  The duty is not there for the money manager, and why that happens, it’s ridiculous.  You ought to be able to go to a money manager and say, “I want you to put my interests first in the way you run the fund.”  And you ought to be able to take that for granted.  I mean, it is common sense.  It’s almost the language of the Investment Company Act of 1940, which says, “Mutual funds must put the interests of their shareholders ahead of the interests of their officers, directors, money managers and distributors.”  It’s all right there in writing.  Nobody does anything to enforce it.  It’s like the policy part of the Act.

David Bear:  Has this changed over the decades, or did it used to be more enforced?

John Bogle:  It’s never been enforced.  Never.  And that’s, on the face of it, kind of shocking.  I don’t shock easily!

Jim Lange:  No, you don’t.  In fact, in The Clash of the Cultures, you wrote a scathing indictment, and I’ll name the different organizations that you indicted: the Congress, the judiciary, the SEC, the Federal Reserve Board, the rating agencies, the financial press, the security analysts, the corporate directors, and institutional stockholders.  Would you like to elaborate on any one of those?  Because you seem to think that there’s some problems that need fixed in all those organizations.

John Bogle:  Well, my favorite target…you know, when you get into the Congress…I mean, the judiciary has trouble dealing with all this.  They don’t really understand the business.  The SEC has not done its job.  The Federal Reserve Board’s a little bit of a different issue because it’s not directly involved in the securities market.  The rating agencies, as everybody knows, used to sell AAA ratings to anybody that wanted to buy them at $400,000, $500,000 a throw.  And my favorite is institutional stockholders.  Today, we large financial institutions, Vanguard and Fidelity and American Funds, and some of the big private money managers usually associated with mutual funds, hold 70% of all the stock in America.  These institutions control corporate America.  They have the power, they have the responsibility, they have the right, but they don’t do very much in terms of corporate governance.  If the owners don’t give a damn about how a corporation is run, who should care?  Probably nobody!  And this is a fiduciary duty issue.  Don’t those institutional investors have fiduciary duty to try and get corporations in line to be run for the interest of their own stockholders, the mutual fund and big institutional money managers rather than for their insiders, their own officers and directors?  You know, things like officer’s compensation, totally off the wall.  Do these institutions not care?  Well, there’s an interesting point, because the institutions are also, many of them, publicly held, and they don’t want any limitations on their own executive compensation.  So, that system has to be fixed, and is comes under the general rubric of you’ve got to stand up and exercise the rights and observe the responsibility to corporate governance in a much more active way than these large investors have done up to this point.

David Bear:  Well, let’s take that final break now, and when we come back, the conversation with John Bogle and Jim Lange will continue.

BREAK TWO

David Bear:  And welcome back to The Lange Money Hour, with Jim Lange and special guest John C. Bogle, founder of the Vanguard Group.

9. Resources for Investors

Jim Lange:  Mr. Bogle, I was hoping that you could give our listeners advice on some resources that they can look up.  So, for example, we mentioned The Clash of the Cultures: Investment vs. Speculation, which is your most recent book, which I just think is wonderful.  But that’s more of a, let’s say, social commentary and not necessarily ‘what an investor should do’ type book.  Would The Little Book of Common Sense Investing, also by John C. Bogle, be one of the very good sources that a listener could turn to?

John Bogle:  Well, far be it for me to say that!  It’s now 7.5 years old, and it’s been the number one mutual fund book on Amazon purchases for virtually every day for 7.5 years.  So, the readers must like it, and I’m happy they do.  It’s written fairly simply.  It’s gotten, like, 280 comments (you can look them all up on Amazon), and most of them give the book five stars.  Now, there are other good books out there.  I’d say Burton Malkiel’s A Random Walk Down Wall Street, which is updated every few years, is excellent.

In terms of individual investment advice about the mutual fund industry, there is nobody, I repeat, nobody, including Bogle, that’s any better than William Bernstein, an investment advisor out on the west coast, who actually had a career as a neurologist before he got interested in this business.  And he has a short book on Amazon, which you can buy for $0.99, I recommend that to you.  He actually swiped the top spot away from me for about a month.  And he has three other books out there.  Any Bill Bernstein book is worth reading, and he writes beautifully.  He’s got the ideas right.  And then, there a couple of other so-called ‘Bogle heads’ that have written books like The White Coat Investor, which is also quite popular.  Right now, the top two books are The Little Book of Common Sense Investing, and another book of mine, much more complex, but almost a manual, which is Common Sense on Mutual Funds.  And it’s got an introduction by David Swensen from Yale University, a very brilliant investor who understands what we’re doing, and understands that this fund industry is deeply troubled.  So, those books would be good places to begin, and they’re well written, they’re helpful and they’re telling you the right thing.

Jim Lange:  Well, let’s not forget about your blog, which is www.johncbogle.com.

John Bogle:  I’m told that I have 525 speeches on there.

David Bear:  Yeah.

John Bogle:  So, be sure and tell your listeners to be selective.

David Bear:  And that’s www.johncbogle.com, and also six minutes of Senate testimony is on there.

John Bogle:  Yeah, the testimony is not bad.  I’d recommend that to anybody.  And then the exhibits from the testimony, including a chapter from The Clash of the Cultures, and the article on mutual fund costs that I wrote for the Financial Analysts Journal are both exhibits to that testimony.

Jim Lange:  Well, Eugene Fama recently won a Nobel Prize for his work on efficient market theory, which goes right along with what you’re saying, and I know that you literally founded Vanguard and are a Vanguard fan, but in your discussion today, you said it’s not just Vanguard.  There are other index funds that are, at least, a reasonable choice.  Would Dimensional Fund Advisors be a reasonable choice for some of our listeners?

John Bogle:  Well, yes it would.  But before I get to that (and I’m glad to talk about it), I just want to give you a little bit of background.  When Professor Fama won the Nobel Prize, several reports said he inspired my creation.  The efficient market hypothesis was the basis of my creation of the first index fund.  Just to make the record clear, I had never read a word from Professor Fama in 1974, ’75.  I didn’t know what the efficient market hypothesis was.  So, there’s no connection between the two.  Further, I would add, sometimes the market is efficient, and sometimes it’s not, and it’s almost impossible for us to tell the difference.  So, how can that be a hypothesis when it can be disproven in numerous ways on numerous occasions?  I’m not sure about that.  The markets are mostly efficient most of the time, but they are not always efficient all of the time.  And even Professor Fama says, “If you stand back far enough, it’s clear that you should own an index fund.”

Now, when you turn to the DFA, I very much respect their organization.  I know the people that run it.  They do a very good job.  They’re actually not indexers as such.  They believe they can find sectors of the market that have greater enduring value than the total market.  To wit, certain kinds of foreign securities, value stocks, so-called, stocks at low price earnings, multiples, small cap stocks, all these things are in the historical data.  But I’m skeptical about them all because the past does not repeat itself in the fund business.  But they do a nice job.  I mean, if you look at the ratings, they’re up there pretty close to Vanguard.  If you look at the percentage of…see if I can do this here, they have a 21% favorable rating, four- and five-star funds minus one and two, compared with Vanguard’s 44% favorable rating.  So, we do a little better, primarily because our expense ratios average less than twenty basis points, and their expense ratios run about forty basis points, on average.  So, they lose a little bit of cost friction there, so they’re pretty comparable.

I don’t happen to agree, however, that anything is permanently undervalued in the market.  People figure it out.  So, I’m skeptical that they will ever be a really serious competitor for the index fund.  They’re doing very well.  These sectors sometimes do a little bit better, sometimes a little worse.  There was a time when they loved Japanese small cap stocks, but we haven’t heard about that for a long, long time.  It’s a difficult task to do all this, to pick out sectors that are undervalued.  But one thing I do particularly like about DFA is they are big voters, they’re very activist in their responsibilities as corporate governors, as corporate owners.  And they actually, it seems amazing to me, but when we look at things like how do institutions vote on minority proposal, shareholders with minority positions to any positions, and they get a proposal on a proxy, DFA, the last time I looked, supported 100% of those proposals.  I mean, that sounds amazing to me.  It sounds even too far.  But most institutional investors support about 5% or 10% of them.  So, they seem to be maybe a little ahead of the curve in their taking corporate governance seriously.

David Bear:  How does Vanguard stack up as an activist entity?

John Bogle:  Well, we have a little difference of opinion here.  In terms of all the data, how often we vote for the directors and how often we fail to vote for minority proposals and things of that nature, we rank very low on the scale, I think 25th out of 26 funds measured in that way.  And that obviously doesn’t amuse me.  But Vanguard’s response is, “It’s not a quantitative issue.  It’s what we actually do.”  And we say (and I have no reason not to accept this) that “We like cooperation better than confrontation.”  So, instead of taking on these issues in public, we talk privately with managers, chief financial officers, chief executives, and try and bring to their attention the problems we have with their proxies or with their structure or with their business.  You know, I want to believe that.  In a sense, I do believe that, but I’d love to get some examples.

David Bear:  Umm-hmm.

John Bogle:  You know, we thought compensation was too high for this company, so we called the management and they said, “Fine.  We’ll cut it.”  That would be a good example.  I don’t know if that’s ever happened.  So, sooner or later, you’ve got to rely not just on someone intentions and their own view of their own practices, whether it’s Vanguard or anybody else, but you’ve got to have evidence.  I guess Ronald Reagan was famous for saying, “Trust?  Sure.  But verify.”

David Bear:  Right.

Jim Lange:  Well, I was delighted with The Clash of the Cultures, and actually your mission, if you will, to provide the best information to mutual fund owners.  And you may or may not know that we have actually had tens of thousands of YouTube views of our last interview, and I’m going to try to promote this interview broadly.  What message would you have for the public that we have not touched on yet?

John Bogle:  Well, I think there’s honestly little I can add to what I said.  Just let me say, overall, as long as you realize the mathematics of the stock market and the bond market, be sure you heavily consider, carefully consider, keeping your costs of investing low.  In the long run, it is the difference between success and failure.  Or to use a phrase I’ve used more often than you can imagine, ‘Don’t let the magic of compounding long-term returns be overwhelmed by the tyranny of compounding costs.’  That’s my big warning.

Second, look at firm’s reputations.  Look at the time they’ve been in business.  Look at how they comport themselves.  Have they had regulatory problems?  Have they had this problem or that?  What kind of mutual funds do they offer?  Are they going to swing for the fences?  You don’t want that.  Sure, you can hit a home run once in a while, but most big home run hitters also strike out a lot.  So, it’s basically…I don’t mean to make the thing too simple, but use your common sense.  How would you like your money to be invested?  You would like your money to be invested the same way that your managers would invest their own money.  And the directors of those funds.  Look at the fund director’s holdings of the funds they’re in.  Sometimes, there’s none.  How could they care?  And be careful of fund groups that are running 150 to 350 mutual funds.  How can they give the right attention to any one of them?  And we run a lot, no question about that.  I think we run about 160 funds.  And it’s very hard to exert a fiduciary duty to all those individual entities.  But as long as they’re index funds, you shouldn’t have to worry about that a lot.

Jim Lange:  Well, this has been a wonderful interview, and thank you so much on behalf of me and all our listeners.

John Bogle:  Good luck to your listeners!

David Bear:  Well, and listeners, thanks for listening to this edition of The Lange Money Hour, Where Smart Money Talks.  And thanks to Mr. Bogle for his time and insights.  You can check out the Bogle eBlog at his website, www.johncbogle.com.

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