John Bogle responds to “Ask Jack” questions
Admin - Jun 15, 2007

Dear Jack:

I am in the process of reading your new book”The Little Book”and in your chapter on bond funds,you state that “the intermediate-term bond index fund is a truly superior performer”.

I owned that fund along with the Long Term Bond Index Fund.Then last year Vanguard developed a financial plan for me in which they recommended that I sell those two funds and purchase the Total Bond Market Index Fund.I did just that and now I am concerned that I made a mistake and should have at least kept the Intermediate fund. I realize you are comparing that fund to Muni Bonds and Gov’t Bonds but I am wondering how you feel about the Total Bond Market Index Fund vs.Intermediate. Would it make sense to hold both? I also own the European Index Fund and it has done very well and I am considering buying the Total International Stock Index Fund and also keeping the European Fund. Again,does it make sense to hold both? Does it ever make sense to hold a part of a total index fund and still hold the total fund.

As you can see I am confused so anything you can do to shed some light on all of this would REALLY be appreciated.

I look forward to hearing from you,
John D

Hi, John,

Thanks for asking about our bond funds. I like the (taxable) IT bond index fund because it provides more stability than the LT index fund, and more income than the ST index fund.  The Total Bond Market Index Fund is fine, but I vaguely wonder about a bond fund that has 35% of its portfolio in non-bonds (i.e., GNMA securities, with their risk of being prepaid early,  when interest rates tumble).

That said, TBMF happens to have a maturity profile that is intermediate-term on balance, and so differs from IT largely in its holdings of GMNAs and Treasurys. Their ten-year records are similar, based on the tabulation I’m sending separately (IT 6.49%, TBM 5.96%, which included a single year–2002–in which we sort of forgot to stick to index principles, costing 2.00%, or about 0.20% per year.  I’m assured by management that such an aberration will not recur.)

As it happens your previous 50LT/50IT strategy was a winning one, as the tabulation shows.  Of course we have no idea which of the above strategies will work best in the coming ten years, but it’s comforting to realize that the results of all six of those shown are almost certain to differ only in degree.

There’s no particular reason NOT to hold two overlapping index funds.  In your case, adding a similar investment in Total International to your present European would simply lower your European exposure from 100% to about 80% of your Intl holdings.  Not much difference, for Eur is about 60% of Intl.

I don’t know nearly enough about your assets and goals to advise you, but I hope this note helps clarify the issues.  Perhaps your Vanguard adviser can explain the reasoning behind your allocations, and discuss possible changes.

Best,
Jack Bogle

* * * * * * *

Jack,

I will be attending the Diehard meeting in Washington dc in June (and previously heard you speak in Chicago last fall).  Will be bringing my 20 yo son-who is relatively new to investing, but shows great promise.

Here is my question. I greatly appreciate making your collected wisdom available on the Web.  However, the files available on your sites are quite formidable.  Could I ask you to select a few that a person new to investing should read?  I would like my son to read these before coming to the meeting-I would also gladly buy whatever book of yours you would recommend.  However, I must admit it would be be difficult to expect a college student with a summer internship to complete one of your books before the June meeting!!

Early in the days of the WWW I came across the following statement:

“Finding information on the Web is like taking a drink from a fire-hose!”

I appreciate you are quite busy, and thank you for whatever insights you may offer. Looking forward to meeting you.

Bob K

Hi, Bob,

Thanks for your kind note.  And looking forward to meeting you and your son at Diehards in DC!

I’m probably, in your words, the Great Information Firehose of investing, and I’d shamelessly recommend my original Common Sense on Mutual Funds, still, despite its 1999 publication date, holding a top 1/10 of 1% ranking at Amazon after all these years.  I also like Malkiel’s Random Walk, Schultheis’s Coffee House, and the Bogleheads Guide, especially for new investors.  (CSMF may actually be a bit complex for such souls.)

And my new Little Book ought to be great for your son (my own grandson, age 13, is actually reading it!), for it’s a short and simple read, easily digestible in a couple of hours and therefore well within your son’s time constraints.

Hope the ideas help.

Best,
Jack B

* * * * * * *

Dear Mr. Bogle,

First of all, I want to thank-you for founding Vanguard and for promoting indexing.  I have had an account with Vanguard for about five years.  After spending many years of investing in managed funds and individuals stocks,  I have learned my lesson about the power of indexing.

This week I read your new book “The Little Book of Common Sense Investing,” in which you make a compelling case for limiting stock investments to an all stock market index.  It is a wonderful book with a clear and powerful message.

My question relates to pages 205-206 of the book.  While you favor the all-US stock and bond market approach, you state that adding a total international stock index fund (of no more than 20%) is a reasonable alternative.  With three such index funds in a portfolio (All-US Stock Market, All-US Bond Market & Total International Stock Index), is there a need for rebalancing on a periodic basis? 

I have heard many investment advisors talk of the need to rebalance a portfolio on a yearly basis  to maintain the original asset allocation.  I wonder if rebalancing is inconsistent with the premise of indexing and whether the power of indexing means that the investor should continue to make investments based on the original investment formula, regardless of how the funds  have performed in the past rather than constantly changing the mix of new investments to maintain the original the original investment balance.  I would greatly appreciate your views on whether rebalancing hurts or helps the benefits of indexing.

Thank-you very much and best wishes,
RJM 

Hi, Mr. M,

Sorry it’s taken me so long to respond to your thoughtful note.  Busy!

We’ve just done a study for the NYTimes on rebalancing, so the subject is fresh in my mind.  Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually.  That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary.

We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods.  Also, it seems to me, noise.  Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big.  (I’m asking my good right arm, Kevin, to send the detailed data to you.)

My personal conclusion.  Rebalancing is a personal choice, not a choice that statistics can validate.  There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio.  Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.

In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value.

Use your own judgment, but perhaps these comments will help.

Best,
Jack

* * * * * * *

Dear Jack,

First off, I want to thank you for all you have done over the years for
small investors. If nothing else, your demonstration of the long-term
effects of investment costs have given some of us the confidence to
break away from our high-cost brokerages and shift our funds into
broad-based index funds. I made this change myself about six months
before I read the “Little Book,” and I have never looked back. 

Since I keep lending the “Little Book” out, I can’t refer to it
specifically, but as I recall, you suggest that index investors may
expect continued long-term returns in the 10% range, in line with
historical results. I noticed that your friend William Bernstein
anticipates in the Four Pillars that future returns, based on the
Gordon Equation, are unlikely to be much above 6 percent. Is this
difference in outlook primarily attributable to methodology, or time
span (you primarily cover the last century, whereas Bernstein pretty
much goes back the the dawn of civilization!)? 

Realizing that neither of you is in the predicting business, I’m not
inclined to make too much of this. Both of you are simply making the
point that in the aggregate, investors will make the market return
minus expenses. But I am curious.

Carl C
Hi, Carl,

Thanks for your kind words!

When you get your copy of my “Little Book” back, you’ll see that my projection for equity returns is about 7%, not history’s 9 1/2% nor Bill Bernstein’s 6%.  The reasoning is in the book, but comes down simply to “rational expectations.”  (Of course, sometimes the market is irrational, as in the late 1990s through early 2000.)

We shall see!
Jack

* * * * * * *

Dear Mr. Bogle,

I’m recently divorced, in my 5th decade, and determined to fly independent!

My answer is simple:  My divorce-inherited after-tax and IRA money is currently in mutual funds that I want to convert into respective S&P 500 Index Funds.  Do you see any problem with timing or diversification? Should I invest some of my IRA money in bonds, and if so, can you recommend a few common sense index funds that would be appropriate, and a percentage .. I’m thinking 20% at the most.

I read your book “The Little Book of Common Sense Investing” and you confirmed what I thought the day I took over my former’s mutual funds. And you were right about another issue — advisors do NOT want to discuss commissions or fees by numbers, percentages, and just what that means to investor return. 

Thanks for reading this and I look forward to hearing from you.

Julie H.

Dear Ms. H,

Belated thanks for your note.  Busy!

While I understand your questions, I don’t know nearly enough about your assets, your goals, or your risk tolerance to give responsible answers.  But you’re right–advisors are expensive, and index funds–stock and bond alike–are “the way.”

Best,
Jack


John Bogle responds to “Ask Jack” questions
Admin - Jun 01, 2007

Dear Jack,

I have just finished your latest book and totally agree with your analysis of Index funds vs. mutuals, as over the long run they will outperform the equity funds. My question is, however, what holding period do you recommend. That is, what is the “long run”? Is the run long enough for folks in their 70s and up to switch over a large portion of their savings to the Index funds ?

Finally, for folks in this age group, are Fixed Indexed annuities appropriate for a portion of their savings? Those products do link to the S&P500 index and, at the expense of not obtaining the full upward movement, they do protect against downturns in the index. With index funds, the Seniors might not be able to have the time to recover losses incurred in a short 7 to 10 year period.

Thanks,
Steve K

Hi Stephen,

With all respect, I believe that your question about the “long run” has more to do with asset allocation than with index funds.

Think about this: for equities, the stock market index fund is the only way to guarantee your fair share of the market’s returns, over the short run and the long run alike. The same thing is true for bonds. (I’ll leave aside here the issues of 1) percent of equities in international stocks, and 2) whether you should hold taxable or tax-exempt bonds.)

So for folks in their 70s, common sense suggests that bonds–which pay generous income and are fairly safe–should predominate the allocation, and stocks–stingy with income (and, for actively-managed equity mutual funds, pay almost nothing) and fairly risky–should make up a smaller portion.

Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high return. I’m personally not particularly smitten with most index-linked annuities, because they charge more for the “put” than its actual value. Someone (maybe Vanguard) ought to figure out a better way.

Best,
Jack

* * * * * * *

Dear Mr. Bogle:

In your most recent book, you advocate the use of a broad-based index fund (with a greater preference for an all US equities approach) for the equity portion of ones portfolio. You emphasize that trying to guess which segment of the market will “win” in the future cannot be determined any better than the futile attempts by market gurus to time the market or select the best individual stocks (at least after taking into account the cost of financial intermediation). You also say that there is a tendency towards “reversion to the mean” of any segment of the market that is momentarily doing better (or worse) than the overall market.

Another book by a different author (Larry Swedroe’s “The Only Guide To A Winning Investment Strategy You’ll Ever Need”) also emphasizes the inherent sensibility of using a passive approach to investing. However, the author feels that certain segments of the market, such as small stocks, offer greater opportunity for larger returns due to the greater risk associated with these segments, which gets reflected in the pricing of such assets. The author recommends overcoming much of the greater risk of those market segments (or “asset classes”) by broadly diversifying within those segments using passively managed funds.

What is your view on placing greater (but certainly not exclusive) emphasis on some of the these riskier market segments by using passively managed index funds as a way of improving the returns on ones portfolio without a commensurate increase in risk?

I thoroughly enjoyed your Little Book on Common Sense Investing and am currently thinking through how to put its principles to work. The variation on your theme suggested in this other book was intriguing and I wondered how you view such “tweaks” on the general notion of passive investing that you’ve championed for so long. Your insights would be much appreciated.

Best wishes,
Jerry K

Jerry,

Good question!

Fact is, I’m not one for trying to guess which styles will outperform or underperform–or when–and the data clearly show such changes are anything but sustainable or predictable.

We’ll send you the data tomorrow on small-cap value stocks vs. the S&P 500. You’ll see that SCV underperformed from 1926 to1942 (14 years), did nothing from 1944 to 1963 (another 19 years) and again from 1968 to 1976 (eight years) and yet again from 1979 to 1999 (another 20 years). That’s a mere 61 years of the 79-year period where SCV was not a winning strategy.

Admittedly, the explosion in SCV relative returns from 1999 through 2004 was impressive to a fault. So I’d definitely advise you to follow the strategy . . . but only if you can buy the style at 1999 prices.

My guess–alas, it is little more than that–is that today will prove to be a bad time to commit your assets to yesterday’s winning strategy. So if the temptation to do so is overwhelming, just do a little teeny bit.

Good luck!
Jack

* * * * * * *

Hi Jack!

Thank you so much for your LITTLE COMMON SENSE BOOK OF INVESTING. It is my introduction to you and I appreciate the opportunity to get to know you. Towards the end of the book you say that you don’t imagine anyone would do exactly as you advocate with an all index portfolio, holding U.S. stocks and bonds. My opinion is that I can’t imagine anyone reading the entire book and NOT doing as you suggest!

My question is this. I now realize that holding the entire U.S. Stock Market does indeed give you international exposure. However is it really enough considering the amount of outsourcing that continues to climb? And as U.S. companies realize the tax benefits of setting up shop overseas, they will eventually not even be U.S. companies any more. Is it therefore wise to have a percentage of your serious money account in a foreign index fund?

Many Thanks,
John G

Hi John,

I’m delighted that you found TLBCSI to be persuasive. I’m so pleased that it’s doing so well in the stores. After all, what good’s a sermon without a congregation?

My own belief is that the US international exposure is adequate for most investors. In fact, outsourcing makes US firms more profitable (at least in the short run!), even as the weak dollar increases foreign purchases of US goods and services, adding to their profitability. Yes, “on the other hand” (as the economists say), the weak dollar also make foreign stocks more attractive relative to US stocks, and it would take more courage than I possess to predict a stronger dollar in the forseeable future.

My traditional position was that currency fluctuations are impossible to time, and that they wash out over the long run; hence foreign holding should not exceed 20% of equities. After the strong dollar’s long run in about 1991-2001, I thought foreign stocks should in fact represent about 20%. But today, with foreign markets–particularly emerging markets–having had such a long, strong run, I’d say don’t rush to hold that position–average in over the next few years.

All of this smacks of timing, and of course it is! And I pretend no expertise in that area. But I believe that the main benefit of international diversification will not come from timing, but from a broadenede array of companies that represent the widest possible variety of leading companies. (I.e., some of the better auto, health care, and technology companies are headquartered outside the US.)

With that, you’re on your own. Hope it helps.

Jack

* * * * * * *

Jack,

I brought your books common sense and the littlest book on audible.com. It is easy to listen to on my iPod. Enjoy listening while at the gym. Are you going to write another book?

Thanks,
Jim

Hi Jim,

I’m glad you liked my Little Book, and also enjoyed it on tape. (Though several listeners said it would have been more “alive” if I’d done the talking. Too late for that now.)

Another book? Who really knows? Writing is a disease with me, and sometimes I think that my passion for it will never stop. “On the other hand” (as the economists say), it’s demanding work. We age! And what seemed like a little hill yesterday may look like a mountain tomorrow. But, as the old saw goes, we climb it anyway, “because it’s there.”

Stay tuned, even though I can’t tell you what to listen for.

Jack


John Bogle responds to “Ask Jack” questions
jcbadmin - Mar 29, 2007

Following are Mr. Bogle’s responses to just a few of the hundreds of emails he has received to the Ask Jack section of the site. We’ll post more as his schedule allows.

Dear Mr. Bogle,
I must tell you that I have “seen the light” when I have read your excellent books (“Common Sense on Mutual Funds” etc. and I’m waiting the new “Little Book” from Amazon in March). Your books really opened my mind for investment mechanism. I learned that I have made all the possible mistakes during my past private investor career… and lost money. I would like to thank you very much for opening the road to go with my future long term investments.

Lately I have seen you hammering quite hard Index ETF’s on your speeches and articles. I would like to tell you that for me as living in Finland the ETF’s are the only way to own total market indexes, like Vanguard one’s from the US market.

Such things do not exist in Finland. With ETF’s it’s possible to do my investments thru the internet and have my share of market growth…

So (finally my question), used in the right way (total market index, buy and hold) ETF’s can’t be a bad thing, or how?


Thanks for your thoughtful note.

You’re quite right. Used in the right way, ETFs can be wonderful investments–and surely provide a particularly great convenience to non-US investors. So buying and holding an all-market ETF (especially a very low-cost one!) is a good thing.

The problem I have with the ETF business (as spelled out in my brand-new “Little Book”) is that the field is dominated (678 of 690 ETFs, to be specific) by narrowly-focused funds (single
country, single industry group, sometimes leveraged) that are traded like hot stocks. A half century-plus in this business has convinced me that such performance-chasing is a loser’s game for investors (and, of course, a winner’s game for brokers, managers, and marketing entrepreneurs).

So glad that my books have been helpful. “Stay the Course!”

* * * * * * *

One of my favorite books is Bogle on Mutual Funds.  Even though it was published about 12 years ago the advice is timeless. The same can be said for Common Sense on Mutual Funds (somewhat more current).

I read bits and pieces that indicate that you may have made minor changes to your investment advice since Bogle on Mutual Funds came out. In some cases new products have emerged such as TIPS and the Inflation Protected Securities Fund. In other cases you have perhaps changed your preference for the Total Bond fund to Intermediate Bond Index. The pie charts used as examples in the book seem to place a value emphasis with large portions allocated to actively managed equity income funds as opposed to a straight Total Stock fund.

I would love to see other things addressed in an updated version of Bogle on Mutual funds including:

o Whether your recommendations on International Funds have changed.

o Whether you feel REIT funds deserve a specific allocation.

o What portion of a bond portfolio should be allocated to TIPS.

o Comments on withdrawal percentages/strategies in the distribution phase. Whether the Trinity study should be used as a guide. Straight percentage vs. initial percentage with inflationary increases.

o Whether actively managed funds should make up 50% of the domestic equities (as Vanguard planners currently recommend).

o Tax advantaged investment vehicles vs. non deferred investments.  What mix best accomplishes current tax advantages vs. potential repercussions in the distribution phase.

o Your feelings on the new Target Retirement funds.

o Whether you feel immediate fixed annuities can/should play a part in asset allocation.

o How pension plans, annuities, and/or social security should impact asset allocation. Example: if one is fortunate enough to have basic needs taken care of with a combination of the three how should this impact asset allocation for stocks and bonds?

I could list numerous other questions or things that I would love to see in an updated Bogle on Mutual Funds. Or an updated Common Sense on Mutual Funds if you prefer. I know you’re very busy these days but you would be doing an enormous service by publishing your current views and advice.

If you decide to proceed with an update and would like additional questions or thoughts I would be happy to provide you with a more detailed e-mail.

If you would prefer to write a new book rather than update one of your classics I could see it entitled: “Bogle on Asset Allocation- How to invest at all stages of your life.” Or, more selfishly: “Bogle on Retirement Investments- How Boomers can transition from accumulating assets to the distribution years.”

As you can probably tell, I would enjoy reading anything that you write and take your wisdom very seriously.


Thanks so much for your incredibly thorough, thoughtful–and helpful–note.

With my new “Little Book” (my sixth) now in the stores, I’m thinking–but only vaguely; writing is hard, demanding work–about my next major project. I’m being pressed to do a new edition of Common Sense on MFs, though my heart (a different one than when I wrote it) belongs to Bogle on MFs. However it comes out, your suggestions for an update are right on the mark. ETFs and value-weighted indexes would also be on the list, though I cover both in the new book. (“Ay, there’s the rub.”)

When that particular d-day comes, I’ll darn well call on those additional ideas you have, and deeply appreciate your offer.

As well as your generous appraisal of my work!

* * * * * * *

Jack:

First, congratulations on celebrating another birthday for your new heart. I wish you many more.

The reason I am emailing you is to introduce myself. I am on a quest to transform the mutual fund industry, much like you have spent your life doing.

I started a money management business that piggybacks off the work that you have done, and sprinkles in some of Buffett’s tenets as well.

I started my career by earning an MBA at Columbia Business School, and then worked on a six billion dollar large cap value. While working there, I learned first hand why the majority of mutual funds underperform the index. I learned that mutual funds don’t underperform due to lack of intelligence or hard work. They underperform because they are structured to do so. Warren Buffett has said that as he looks back over the course of his investing career, he gets around one good idea per year. A typical mutual fund, on the other hand, typically has 100 or so ideas at any one time. Factor in market efficiency, and the majority of those ideas are mediocre at best. Trading in and out of mediocre ideas is a quick way to underperformance. On top of that, mutual funds are usually well diversified, which flies in the face of Buffett’s insistence on circle of competence. It is very rare to find a manager, or a team of managers, who are both experts in every sector and who are also good investors. Thus, mutual funds are usually investing in sectors where they do not have an edge. Again, investing outside of your circle, in an efficient market, is a recipe for underperformance. There are some other reasons, such as cash holdings, but you know the drill.

What I learned:

I learned that I get just a small handful of good investment ideas per year. These are ideas where I find myself saying “Holy cow! I can’t believe the stock market is acting like this.” Again, these are rare moments for me, but they do come. In my quest to beat the market indexes (which is the only way to provide value for my clients, as I believe that many money managers are foregoing their fiduciary duty by managing money as they do), I have combined the brilliance of the index with selective active management. In a nutshell, I start by placing 100% of client funds in the index itself. For this service, I do not charge a management fee (how can I charge someone for doing what they can do themselves?). From there, I search long and hard for an exceptional investment. When I find one, I determine the correct allocation (ballpark around 3% of assets) for the newly found security. If I believe 3% is the right position size, I sell 3% of my index holdings, and place the funds in the new security. I then continue to search for more stocks to buy. I launched my fund in November of 2005, and currently I have 3 active positions which make up a little over 10% of my fund. The rest of the assets are in a S&P 500 index fund. I charge my clients if and only if I outperform the S&P 500. If I do outperform, I take 33% of the outperformance. While 33% may sound steep, it would take a truly monster year to garner the 1%+ that most mutual funds charge, and they are charging even if they under perform. As of December 31, 2006, I have returned 20.22% vs 18.80% for the index, after fees (inception date is 11/03/05).

One more thought: Selling a stock is a big problem for most money managers. When they wish to sell off a position, they need a new idea on-call. New ideas are hard enough to come by, but needing them on-call as a place to invest the sale proceeds is very difficult, and often leads to poor investments, further depressing returns. For my fund, I always have a place to invest sales proceeds, and that is in the index itself. In theory, my worst investment should be the index, which will outperform most active managers.

Anyway, I thought you would like to know how your work and ideas have influenced me, and my work.


Now that my heart is 36 years plus one month old, it’s probably time to answer your wonderful note!

I love your investment philosophy. While I’m pretty much entirely indexed (all Vanguard, including our index-like muni funds), I recognize that few investors will follow that narrow strategy. Indeed I basically endorse what you’re doing (perhaps a bit too cynically!) on page 202 of my new “Little Book.” (I should quickly that the “yes” regarding commodities on page 203 is a typo. I wrote “no” and the printer–doubtless a commodity speculator!–reversed it. To be fixed in the next printing.)

As Warren B notes about waiting for the outstanding investment opportunity, it’s like being a batter in a baseball game where no balls or strikes are ever called–you just until that poor, tired pitcher (“Mr. Market,” in a sense) finally throws a ball that you can hit out of the park. Your reinvestment strategy is all common sense, and your fee structure is a model of fairness and fiduciary attitude.

I’m confident that you’ll serve your clients well. “Press On, Regardless!”

* * * * * * *

Dear Mr. Bogle,

I’m a young man in my mid twenties, and I have an entrepreneurial dream of erasing financial complexity. I started a blog not long ago, Removing Complexity in the hopes of sharing various points on personal finance that I know and am also learning as I continue my own education on the subject, and also because I found a lack of discourse in an industry that thrives on confusion and misinformation. I arrived at your blog because I share many of your views, and was hoping I missed, and might find through some connection to you, some forum of conceptual or directional conversation about where the industry should go. However, I’m still left with the question, “where is the public discourse?”

This is a question you yourself asked in one of your recent speeches that you posted on your blog, “The Battle for the Soul of Capitalism: Doing Your Part to Begin the World Anew.” I’m not so much looking for an answer as continuing some discourse on the subject, which you started by posting your speech on your blog, by offering some of my own thoughts. Additionally, I am publishing this email to you on my blog, along with a link to your site and the speech, where my readers and others might participate as well. I hope and would appreciate if you had the time to read this and respond as your schedule might allow, but in any event, thank you for putting your thoughts out there already.

I agree with most everything in your speech, however, I think a couple points were missed, and I’ll propose some changes that are required in turn. In your Battle for the Soul of Capitalism speech, you highlight the distinction between a past owners’ capitalism and today’s agency capitalism – the pathological mutation. I would agree that this agency model has produced companies that “came to be run to profit its managers” (p4, a quote by William Pfaff) and that this is bad for investors. However, I think this move away from a traditional owners’ capitalism to an agency model has produced much social value. Additionally in another speech, you connect this agency model of capitalism to a rise of the expectation market – a move away from the real intrinsic value market. Again, though, I would disagree that this is wholly bad, and there are some lessons we can learn from these situations.

We have the agency model today thanks to the continued expansion of investment options and the growing availability of those to the general public. Your own contribution of creating the index fund and providing it through Vanguard has greatly helped as it addresses a number of the cost and manager compensation problems in the mutual fund industry (although index funds are still vastly under appreciated and unknown as my own parents didn’t know what they were until I convinced them to move their investments into index funds from Vanguard). That openness and inclusion of a large portion of the population has been a wonderful benefit to capitalism. However, these people are starkly different from those who participated in the past ownership model.

While, in your speech, you hope for a return to the ownership model, you also acknowledge that it won’t happen. Additionally, you criticize the expectation market connected with the move to an agency model, but I think you misunderstand the inherent benefit in that for these new investors. These new investors, which include baby boomers like my parents, don’t care about actively tracking investments and understanding the real intrinsic market. They have an expectation of return from the market, but benefit little from taking the process much further then buying diversified mutual funds, especially broad market index funds. That expectation is derived from at least a basic understanding of the real market, though, and they put faith in the expectation of overall return. In that sense, the expectation market is good for these new investors who prefer minimum interaction with portfolio management.

The problem that you note, though, is that of “short-termism,” which I believe is a direct product of the expectation market. However, we’ve arrived there because these new investors preferred minimum interaction with their investments, and preferred the mutual fund managers as the established experts. These professionals then saw the value in fighting for more investors and larger funds, and have driven the mostly unaware public into a frenzy for greater than market returns (which Jonathan Berk and Richard Green [2002] have shown kill a fund’s returns). Mutual funds learned that they could prosper if they became more like salesmen and marketers, and less managers of investors’ money, and in doing so, they’re listening to these new investors and speaking to them in their own words (albeit confusing investors more than clarifying, but this only drives them deeper into managers’ pockets).

What needs to be done is not return to the old ownership model, but an education of future managers, beyond relearning “trust and being trusted,” and include an education on these new investors – what they care about, how they communicate, and how to build relationships with them. They must learn to speak not in investment terms, but the terms of those disinterested in investments beyond providing a better and more solid retirement or other goal, and the first step in doing so is throwing out the very term investor. Investors take care to understand the intrinsic value of the markets, and find ways to make money in that real business world. The new investor, the indexer, or casual investor, is tired of being confused by current fund salesmanship. They themselves must be spoken to in plain terms that help them understand the value of low cost, long term in the face of chasing higher returns. Academic studies and discussions at universities don’t help foster that any better than pundits discussing politics helps clear the air.

As people like Doc Searls, a coauthor of the Cluetrain Manifesto, and Hugh MacLeod, known for the Global Microbrand, have helped redefine the communication between media and companies in general for the benefit of both consumer and company, the personal finance and investment industries need to learn and draw lessons from that situation, and reconnect properly in open dialogue with old investors and new about their values. We cannot accept the current environment, but must push forward in improving our relationships with all parties.

Thank you for reading this. Any comments or thoughts would be much appreciated.


What a fine and thoughtful letter!

Its special beauty was that you began to answer my poignant question by providing a thoughtful, thorough, and rational discourse on the issues raised in my Battle book and related speeches. The first evidence I’ve seen, other than Randy Rothenberg’s reflections at my speech to the Aspen Institute at breakfast a year ago. (Both are available on my website.)

Time does not permit me to respond to all of the well-taken points in your letter, but I continue (especially in my new “Little Book”) to try to simplify, simplify, simplify (after Thoreau), trying to bring common sense to the average investor, even if only one investor at a time. I do think that the fact that indexing is almost an article of faith with most of our finance and MBA professors is sending out into the world a whole new breed of apostles–perhaps only for their own investments and those of their friends and family–even though many will plunge into careers in money management that, in the aggregate, will increase the costs incurred by investors all the while reducing their net returns. The monster must be slain!

Perhaps someday we’ll have the opportunity to continue this discourse. But thanks for starting it!

* * * * * * *

Mr. Bogle,

In researching your work I don’t understand one point.

If everything you say is true regarding the relationship of fees to investment performance, where did you come up with the statistic that “passive” investing beats 90% of the active managers?

I would think it would beat 99% of the managers!!!!!!!!


Thanks for writing. The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it’s likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years . . . well, there’s no data (yet!) on that!

But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index. There’s a nice chart on page 124 of my new “Little Book” that makes this point, with accompanying discussion.

But beware of all data. (Always a good rule!) While the convention is to say “all investors” or “all active managers,” the simple and obvious reality is that we’re actually speaking of all invested dollars in the same discrete universe as the passively-managed index itself, not the number of investors or mangers.

Hope I haven’t told you more than you want to know.

* * * * * * *

Dear Mr. Bogle:

Is there any risk that Vanguard could someday change its structure, or behavior, in a way that could work against current shareholders? I am not familiar with the organizational details, but I have the perception that ever since Herb Allison (formerly President and CEO of Merrill Lynch) was hired as CEO of TIAA-CREF, that the organization is not as consumer-friendly as it once. I know that David Swensen lauds both in his book, but my sense is that TIAA-CREF has slipped relative to Vanguard. Is that true, and could something similar happen at Vanguard?

I’m enjoying your blog!
Your question is a good one. Of course there’s always a risk that leopards can change their spots. Times have a way of changing, and personal financial ambitions, especially in this new age, seem boundless.

But I think that a change in Vanguard’s structure is highly unlikely. It would have to be approved by our independent directors, and by you and other shareholders–who, I hope, would “see through” the proposal and would not endorse the higher fees that would necessarily be entailed.

As to a change in management behavior, who can really be sure? Certainly the change at TIAACREF is surprising and disappointing, but perhaps will send a message to our board about the importance of being ever vigilant in recognizing that Vanguard was built on values, character, and reputation, and that losing them would be a tragedy, not only for our owners, but for our firm.

And as long as I’m around, I’ll continue to do my utmost to maintain those values, that character, and our reputation.

* * * * * * *

Dear Mr. Bogle,

I’d just like to say thanks.

I read your book – Bogle on Mutual Funds – about ten years ago.

And, even better, I followed your advice as shown in the model portfolios chapter.

Now, as I approach retirement, it looks like I’ll actually have enough money to retire.

Again, thanks for your book and the advice.

PS: Just as a point of information, I’ve bought and read a number of your books and articles – and even your senior thesis – since then. But if there had only been one book, Bogle on Mutual Funds would have been enough.
Belatedly, I extend thanks for your kind and encouraging note. Of course I’m delighted that your investment program did just what it’s supposed to do. And I’ve heard the same wonderful news from many other investors.

I agree with you that BOMF would be “enough” for most investors. The messages in my next four books added to that advice, but largely at the margins. And my sixth book–the “Little Book” that was published in eary March–is focused, laser-like, on indexing, but is written in a breezier, more (as they say) “accessible” style. But the central message has never changed . . . and never will.

* * * * * * *

Would you mind offering your dispassionate analysis of the principles that inform DFA
investing?

I’m a firm believer in all-market indexing—owning the entire U.S. stock and/or bond market, overweighting or under weighting no particular style or sector, and holding it forever. This strategy, executed at minimal cost, will guarantee that you earn your fair share of whatever returns our financial markets are generous enough to provide. The DFA approach is, in some respects, different. DFA has, I suppose, been a pioneer in offering index funds that cover niche benchmarks that it regards as providing excess returns (i.e. value, small-cap, etc.).

Some financial advisors whom I respect greatly utilize DFA funds, and they believe that overweighting small and value stocks will continue to boost your returns as it has in the past. But I know that we all can’t do so. And wiser heads than mine will have to determine how much exposure US investors need to something like small Japanese or international value stocks.

Minimal cost is an important part of any investment strategy, and all-market index funds can be acquired with no sales loads and minimal annual operating expenses (as low as less than 0.10 percent). Most DFA funds cost considerably more—with expense ratios in the 0.50 percent range, plus a fee of perhaps 1 percent to the advisor who sells the funds. Will their funds’ performance be able to overcome this cost handicap in the years ahead? Well, time will tell.


All about “Ask Jack”
Admin - May 12, 2006

Every month we’ll pick five questions selected from submitted emails and JCB will answer them.

Please note that Mr. Bogle cannot answer questions or offer advice about your personal investments or your Vanguard account.

 Email your questions to askjack@johncbogle.com