Russ Roberts

Bogle on Investing

EconTalk Episode with John Bogle
Hosted by Russ Roberts
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The legendary John Bogle, founder of the Vanguard Group and creator of the index mutual fund, talks about the Great Depression, the riskiness of bond funds, how he created the Index 500 mutual fund--now the largest single mutual fund in the world--how the study of economics changed his life and ours, and Sarbanes-Oxley. At the end of the conversation, he reflects on his life and career.

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Readings and Links related to this podcast

Podcast Readings
HIDE READINGS
  • John Bogle's Home page
  • The Bogle eBlog
  • Books by John Bogle:
  • Lecture remarks by John C. Bogle:
  • "Sarbanes-Oxley (SOX), Belts and Suspenders: The Regulatory Aftermath of the Corporate Accounting Scandals", by Richard Mahoney. Econlib, February 2, 2004.
  • "Good Timing: A Mutual-Fund "Scandal"?", by Fred McChesney. Econlib, January 5, 2004. How mutual funds work.
  • Great Depression, in the Concise Encyclopedia of Economics.
  • Efficient Capital Markets, in the Concise Encyclopedia of Economics. Information in asset markets.
  • Financial Markets. Definitions and links.
  • Highlights

    Time
    Podcast Highlights
    HIDE HIGHLIGHTS
    0:37Intro. Did growing up during the Great Depression affect you? Fortune vanished, had to work for what we got. The Little Book of Common Sense Investing: Stock market is "a giant distraction." "Investment is about owning businesses," not owning stock. Self-imposed portfolio rules, peek once a year. Sports analogy. "Investing is simple but not easy." Bogle's portfolio: 60-40 fixed-income/equity.
    7:11How do you find the right vehicle for the low-risk portion? Bond funds still have interest-rate risk. Bond market is homogeneous. Managers have very little ability to add significant value, but a lot of ability to detract from it. Load funds, commissions equal about first year of income, transactions costs eat into another .25% per year. Bond funds thus deliver only 3.75%. Vanguard has a series of bond funds: short, intermediate, long. Short term bond funds fluctuate but may do better than money market fund. Longer terms, more risk, slightly higher premium. When buying a long-term bond fund to hold, you want interest rates to go up because the reinvestment rate goes up.
    14:22You majored in economics at Princeton. Do you remember anything from those classes? Senior thesis: funds can't beat the market, inspired by stumbling across December 1949 Fortune article on mutual fund industry. Remembers Paul Samuelson's book; quote on free competition and capitalism—problem is "it's never been tried." Bogle's senior thesis in a class with Fred Smith's on overnight express. Airplane travel seatmates often confuse economist with financial analysts.
    19:57How did first index fund get started in practice? 1975. Bogle's fired as chief executive of Wellington Management Co., but directors allowed him to move over into accounting and legal compliance. Marketing and investment management key. Read "Challenge to Judgment" by Paul Samuelson, reminded him about mutual funds. Made persuasive case to directors, computations by hand, got permission to get index fund going. Initially called "Bogle's folly!" Opening didn't raise enough money to buy all the S&P stocks—underwriters only raised $11 million and suggested sending the money back.
    25:37Why indexing works: More diversified than the average mutual fund at lower cost. Investors understand that the lower costs are desirable. Investors put up 100% of the capital and take all the risk, but after managerial costs end up with only 20% of the return, with 80% going to the managers. Yet many investors still believe they can pick the smart managers and thus do better with a managed fund than with the average index fund. For investors, it's easy to look back but difficult to look forward. "Performance comes and goes but costs go on forever, just like clockwork." Top ten funds in 1996-1999 were dead last three years later. Performance-chasing conventionally makes investor his own worst enemy. Typical mutual fund investor earns about 3 percentage points less per year less than the typical fund itself! Inflation eats away most of that, not to mention taxes.
    31:21Economics has very little to do with the stock market, but has everything to do with how business does. Businesses—corporate earnings—grow about same pace as economy (long historical GDP growth rate about 6%). Importance of information, public and private. Bill Miller beat the S&P for a long time and picked Amazon.com, but did well by randomness, not by having inside information. Publicly available information is embodied in the price of the stock. Buy and hold strategy. "A good fund underperforms one year out of three"—going in and out is not strategically beneficial for investors, buying at high and selling at low is not a good plan. Actively managed funds are still offered at Vanguard, though. Why? Loyal clientele. Strategy is to make managed funds have same characteristics that make indexing attractive: no sales load, manager fees kept low, find managers who invest for long term, give the manager a discrete sector of the market, don't just use one manager ("the average value manager is average").
    40:05What is impact of Vanguard's cost focus on competitors? Have forced industry to pay attention to costs, but industry costs still high. Money market funds vs. index funds. Information asymmetry: sellers know a lot of things that the buyers don't know. Slow process, not overnight. Hedge funds: lately stealing better managers, but charge higher fee. Very diverse, some run better than others. Hedge fund tax efficiency issues, hiring, track record to consider.
    45:57Honesty and trust: The Battle for the Soul of Capitalism. Bogle: Sarbanes-Oxley bill of some sort was needed because of lack of financial controls. GM's errors in financial controls affected 5 years' earnings. Section 404 is only complaint by business community in the regulation. Some provisions not applied: law calls for disgorgement of mis-stated profits, but that hasn't been enforced. If private system isn't working, have to bring government in. But doesn't marketplace punish the misbehaviors by not buying their stocks? Both government and market are imperfect, but which does better? Factor: agents of owners don't care as much as direct owners. Funds and managers have to be given same incentives as owners.
    53:01What are you proudest of? Focus has been on journey, not destination. Pleased to have had opportunity to build a better world for investors, to start a unique kind of company that has yet been un-copied, to have made the most of good luck. Disclaimer: Russ does own some Vanguard products. Economically, more money has gone into capital markets than otherwise would because of Vanguard's innovation making it more feasible for common investors, but hard to measure.

    COMMENTS (4 to date)
    Valerie writes:

    This was an excellent interview. The only thing that made me raise my eyebrows was when Bogle said he thought some form of Sarbanes Oxley was necessary and the interviewer disagreed with him and thought that the markets could take care of it.

    NR writes:

    Bogle splits his investments 40% equities and 60% FI? I would have liked to ask him why it's so conservative. True the conventional wisdom is to get conservative as you age, but surely Bogle is wealthy enough and secure enough to take more risk. Buffett may be an extreme example, but he's 100% equity (his own)...

    Second, I've always wondered at the irony that though a proponent of capitalism as an engine of wealth creation, Bogle obviously doesn't think that the profit motive works for fund management. Maybe so but Why? What's the source of the market failure?

    Russ Roberts writes:

    NR,

    I think the question is really one of what he wants to do with his money when he's gone. What happens to his estate at his death? Does it get cashed out? If yes, I don't think the size of the estate makes risk-taking more attractive. If it passes on to his children, then it's a totally different story.

    Can you clarify what you mean by not trusting the profit motive? Are you arguing that if the profit motive works, then a wise fund manager would just mimic an index?

    BJCefola writes:

    I was struck by Bogle's comment that businesses today operate with a "management" culture rather then an "owner" culture. He laments the lack of aggressiveness by directors in policing executives, reflecting an uninterested and uninvolved pool of shareholders.

    Wouldn't index funds by their nature push such a separation? The philosophy of an index fund is to play an average and ignore the specific. They will not divest holdings in a company that is badly managed, nor will they increase holdings in a company that is well managed. Implicitly they treat judgments of 'good' and 'bad' management as untrustworthy, favoring diversification across an arbitrary spectrum like the SP500 or Russell 2000. One could call it a post-modern investment strategy. The empty chair where the owner used to sit is a logical consequence of such a philosophy.

    True or false?

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