Mutual Fund Legend John Bogle: What’s Costing Investors Two-Thirds of Their Market Returns
In this exclusive interview, the Vanguard founder offers advice on how to boost investment income during retirement and much more.
Back in 1951, the mutual fund industry was tiny, and index funds didn't exist. Enter John C. Bogle. That year, the young Princeton graduate went to work for Wellington Management Company. By the mid 1970s, he had founded the Vanguard Group, now the largest U.S. fund family, with more than $3 trillion in assets, and created the first index mutual fund.
Mocked in its early years as "Bogle's folly," the Vanguard 500 Index fund is now one of the world's largest funds. And its creator has been vindicated in an even bigger way: Index funds now account for roughly 30% of total fund assets, up from 14% in 2005, according to Morningstar. Vanguard, meanwhile, continues to play a leading role in driving down costs for fund investors. The asset-weighted average expense ratio of Vanguard’s funds dropped to 0.12% in 2015, from 0.18% five years earlier—the largest percentage decline among major fund providers.
Although Bogle transformed the fund industry, he never changed his stripes. At 87, the heart-transplant survivor is still battling for the same principle he laid out in his senior thesis at Princeton: Mutual funds' "prime responsibility must always be to their shareholders."
In this lightly edited conversation, Bogle reflected on today's markets, his lengthy career and his ongoing fight to put fund investors first.
Congratulations on 65 years in the fund industry. Do you think the markets have changed for the better or the worse during that time?
Oh, I'd say much for the worse. There’s much more speculation. Portfolio turnover is much higher. High turnover is great for Wall Street and bad for Main Street. Too much of the rewards of investing are diverted to the sellers and not the people who put up the money. And the average expense ratios have gone up since 1951, even though we've had a lot of growth at Vanguard and have come to dominate the market totally.
This was an industry that was ripe for disruption. And we have been the disruptor. The rebirth of this industry is all around index funds.
Yet despite that, the average expense ratio has gone up?
It's a highly profitable business. The key of this whole thing is making sure investors get their fair share of the market's return. If you own an index fund, you can get the market's return for 0.05%. And if you have typical active management, the costs are at least 2% per year. So if the market returns 7%, the index investor gets 6.95%, and the active investor gets 5%. If you put 7% and 5% on a compound interest table, $1 at 7% a year will grow over 50 years to about $30, and at 5% it will grow to about $10. You're getting a third of the market return, even though you put up 100% of the capital and took 100% of the risk.
What’s your advice to retirees who are struggling to generate income from their investments in this low-yield world?
In whatever category they're in, in terms of mutual funds—bonds, stocks, whatever—they can and must look at the expense ratios of the funds. If you look at the large cap funds, an index fund—say our S&P 500 [Vanguard 500 Index Admiral shares] has a gross yield of 2.06%, an expense ratio of 0.05% and a net yield of 2.01%. We took the five largest competitive funds—large-cap funds—and their gross yield was 1.87%, their expenses were 1.26%, and their net yield was 0.61%. So investors should look above all at the amount of yield consumed by expenses. To give up 68% of your income to the manager is not going to help you get income.
Number two: Don't reach out for yield. Reaching for yield is like going out on a limb of a tree. When you go out too far, the limb snaps.
If you want to go into a high-dividend-paying equity fund, look carefully at the portfolio. These funds give you a higher yield and probably a little bit more risk. Our high-yield dividend fund [Vanguard High Dividend Yield Index] has a yield of 3.04%. So that's a one percentage point improvement over the S&P 500's yield. Doing that with a portion of your assets, maybe 10 to 20%, is not a dumb thing to do.
How do you generate income in your own portfolio?
I'm about 50/50 bonds and stocks, and that goes back to an era when bond yields were much higher than stock yields. Municipal bonds are attractive to me. My largest investment is in my retirement plan, where I don’t have any tax issues. But in my personal account, I use Vanguard's intermediate-term and short-term muni bond funds, which have the lowest costs and deliver the highest yields.
You've said that investors should expect lower returns over the next 10 to 20 years. What do you say to people who haven't saved enough for retirement and are facing lower returns in the decade ahead?
The stock market is not cheap. The dividend yield is 2%, and over my career in this business it's been about 4% or 4.5%. That's a 2 or 2.5 percentage point dead-weight loss. Earnings growth during the long period of my career was about 5.5% or 6%. That’s too optimistic for today. With GDP [gross domestic product] growing at far lower rates, you'd be doing well to do 4%. That's another 2 percentage points. And valuations in the market are high. So when you put all these numbers together, you're looking at a rate of return on stocks in the 3% or 4% range, before fund expenses. If those expenses run 2%—you can do the math yourself. It's not a very attractive prospect.
Maybe you can get 3% out of a bond portfolio and 4% or 5% out of your stock portfolio. But I think everybody should have some bonds—small amounts when you're young and large amounts when you're old. It's not a precise formula but a policy guideline for asset allocation. I just think that there's not a lot you can do except accept today's yield.
The uncertainty surrounding the presidential election is making a lot of investors nervous. What’s your advice for people who are worried about the stability of the markets and economy in this election season?
It's a vexing, difficult year, with I think two flawed choices. We have a bit of a lunatic fringe going on here, yet the market seems to ignore it all. Investors seem to have great equanimity about the outcome.
Try and discipline yourself not to get excited. Markets fluctuate—fluctuate wildly. I've been through three 50% declines, and I haven't liked a single one of them. People ask me, "What do you do?" I get out one of my old books and read it.
What do you think about the debate surrounding the Department of Labor's fiduciary rule? You've suggested the rule should go even further.
The rule is going to go further, whether I like it or you like it or anybody else likes it. We're in this peculiar situation where the registered investment advisers have been fiduciaries, and brokers are now moving to a fiduciary standard from a suitability standard, but only with respect to retirement plans. If I’m a stockbroker and have an investor with a retirement plan and a regular account, is it really possible I’ll operate his retirement account with fiduciary principles and do something different with his regular account?
Nobody likes change. Nobody likes regulations. But in the long run, the fiduciary duty is going to happen whether we have a fiduciary standard or not. Why? Because investors want to be treated as the first priority of a broker, and the marketplace over a long period will take care of all this.
Back in 1776, Adam Smith said the sole responsibility of the producer is to serve the consumer, and this proposition is so self-evident, I'm not even going to try to explain it to you. That's almost a direct quote from the great Scot. We'd say the sole responsibility of the manager is to serve the investor. We'll get there. Maybe not in my lifetime. But I'll be watching from above.
Like so many people who are well past "retirement age," you've never stopped working. Do we need to rethink the whole concept of retirement?
I don't think you should be forced to withdraw money from your retirement plan once you retire. You should be able to save it up and keep it until you really need it. More people should be informed about the value of waiting to take Social Security. They ought to be much more conscious of expenses on the fund side.
I've fought the good fight and will continue to fight it. I'm happy with Vanguard's growth, although I’m worried about it getting too big. I have no authority anymore except a voice—I think a voice of reason and common sense.