In this interview with Barry Ritholtz for Bloomberg’s Masters in Business podcast series, Bogle tells the fascinating story of Vanguard’s origins, discusses Wall Street’s initial response to index funds, explains what makes Vanguard so unique, and holds a master class on the proper way to invest.
If you have 90 minutes to set aside this week, I highly recommend listening to the entire interview. The return on your time investment would make it well worth it. But even if you only have 5 minutes to set aside, you can skip to virtually any part of the interview and learn something new, insightful, and very applicable to your own investing (plus you’ll be treated to Bogle’s rich, mahogany voice).
You can download the podcast at iTunes for free or listen to it here.
Additionally, I pulled out my favorite parts from the interview for you below.
Why didn’t other asset management firms start offering index funds sooner? Why were they so reluctant?
Well the answer is so simple. Index funds have a real problem: all the damn money goes to the investors. Managers can’t take anything – they’re not managing! [21′ mark]
What makes Vanguard different from other firms that now offer index funds?
Very few people have the scale that we’ve developed, have the technology that we’ve developed, have the efficiencies that we’ve developed, and also – and I don’t think this is self-serving – have the bully pulpit that we have. You know, imagine Fidelity coming into this business – I described that as “dragged kicking and screaming into the business.” So here we have kicking and screaming over here [Fidelity] – and here we have missionary zeal [Vanguard]. The bully pulpit. [25′ mark]
The advantage of index funds
Index funds give you the advantage of long-term compounding of returns while eliminating the tyranny of long-term compounding of costs.
So think about it this way. Let’s assume the stock market gives a 7% return over 50 years. If you get to 7%, each $1 goes up to $30. If you get to 5% (that would be 7% less the industry’s typical 2% all-in costs), you get $10. So $10 versus $30. You put up 100% of the capital, you took 100% of the risk, and you got 33% of the return! As I say to people, if that strikes you as a good deal, by all means do it! [27′ mark]
On outperformance by active managers
It ignores the fact of life in this business – it’s everywhere: Reversion to the mean. Biblically put, “The last shall be first and the first shall be last.” And it happens to hedge funds, it happens to mutual funds, it is basically a fundamental law. [31′ mark][After the go-go era of the 1950s-60s] We went from prudent investment committees buying blue chip stocks to portfolio managers – comets, and not stars – comets that burn out and their ashes drift gently down to earth, and that’s happened to so many, so many comet managers. The real superstars just don’t stay [on top]. [76′ mark]
On diversification into international index funds
I’m not [a big fan]. The reason goes back to when I started thinking about it seriously when I was writing Bogle on Mutual Funds.
Look, U.S. companies get half of their revenues and half of their earnings from outside the U.S. You [already] have an international portfolio. Why do you want a larger one?
Then I say, take a look at what comprises that international portfolio. Your largest investment is Japan. Your second largest investment is the U.K. Your third largest investment is France. Now if returns are developed out of national economic strength, does anybody think that the U.K. and Japan and France are going to do better than the U.S. in the next 10, 15, 20 years? I can’t imagine it.
Now I may be wrong, I’m not saying this is written in stone, but that’s 45% of the money. So if people knew that they were putting 45% of their international money (so called international, “non-U.S.” is a better formulation) in Great Britain, France, and Japan, I mean every one of those economies has real problems: The French don’t work very hard, the Japanese have a structured and deeply aging economy overburdened by future retirement claims, and Britain doesn’t know what’s going to happen if they the exit the European community, nor do they know what’s going to happen if they stay in. [54′ mark]
Can indexing ever get too big?
Well it’s not in the nature of things that indexing could be 100% of the market. If it were we would have chaos. There would be no valuations, there would be no liquidity, there would be no anything. So, what are the chances that indexing would get to 100%? Zero. Right now it’s around 28% of the total market – 35% of the total equity mutual fund industry – so it means that hunk of business is, broadly stated, just removed from the turnover level… So when you put reality in face of the theory that everyone indexes, it’s just not going to happen.
But the other thing is, people follow this statement by saying, “If the market gets more and more indexed, then it will be less efficient. And we’ll be able to beat it more easily.” No! Unequivocally no! Some will beat it, some will lose to it. If the market is less efficient, the winners and the losers will average the market return. There’s no way around that. [65′ mark]
You once wrote, “The stock market is a giant distraction to the business of investing.” Explain.
Investing is about the long-term. And investing is about earning what I call the “investment return,” which is the dividend yield when you go into the stock market and the earnings growth that follows. That’s investment return. The market return also has a “speculative return,” and that is the price/earnings multiple – if the valuations are high or low when you come in. And if they’re high, they’re going to detract from that return. And if valuations are low, they’re going to add to that return. Because the price/earnings multiple reverts to the mean perfectly.
Today (although it’s a little bit higher today because the market is hardly inexpensive) the reality is it’s just about the same level it was in 1900. So we had ups and downs, booms and busts, but in the long-run speculative return in zero. So concentrate on the investment return. Forget the speculative return, which is very difficult to predict. And just get what the business can give you.
Now if you look every day, you’re apt to do something. One of by basic rules is “Don’t do something, just stand there.” And if you’ve been doing that this year, I think you’re a lot better off – this is a tough year so far. Not that bad… although you’d think it was the end of the world. Don’t let the stock market moves distract you. These moves, daily moves, hourly. minute-by-minute moves, they are a tale told by an idiot, full of sound and fury, signifying nothing.” [68′ mark]
What other investors have colored your world view?
Well you certainly start with Benjamin Graham. He’s basically ground zero. [And] Walter Morgan. [73′ mark]
What books would you recommend?
- The Intelligent Investor by Benjamin Graham
- A Random Walk Down Wall Street by Burton Malkiel
- Unconventional Success: A Fundamental Approach to Personal Investment by David Swensen
- Against the Gods: The Remarkable Story of Risk by Peter Bernstein
- The Four Pillars of Investing: Lessons for Building a Winning Portfolio by Bill Bernstein
What do you know today that you didn’t know when you started out in 1951?
- The power of compounding
- The beauty of keeping costs low
- The need to ignore the market
Don’t think it’s easy, don’t think you’re smarter than anyone else. Just get in the middle. Get costs out. And don’t peek.