Funds Maverick Talks 'Common Sense'
After a long career as founder and chief of mutual fund pioneer Vanguard, John Bogle remains a scourge of the financial-services industry. His latest book, The Little Book of Common Sense Investing (John Wiley & Sons)—which is decorated with endorsements from Warren Buffett and other mavens—sticks to his longtime campaign for investing in broad, low-cost index funds. While it may not be the best investment strategy, it's better than just about all the others, he quips.
Bogle, 77, was characteristically feisty during a Mar. 9 interview with BusinessWeek.com reporter Alex Halperin. Edited excerpts of their conversation follow.
Why do you keep pounding this idea about investing in index funds?
That is the $64 question. It works, and yet people don't seem to get it. While indexing was a tremendous success in taking over about 10% of the assets of all equity funds from a base of zero by the end of the 1990s, they're still at 10% of the equity fund universe. They're growing at the same rate as business generally.
I find that deeply disappointing because the success of indexing is not some mysterious thing. It's based on a few very simple fundamentals: the broadest possible diversification, the lowest possible costs, and the highest possible tax efficiency.
Also, an index fund can be held forever without worrying about portfolio managers coming and going (the average tenure is only five years at a typical mutual fund). It's the ideal core investment, and I would argue that any investor who decides that their equity position will be 100% in an index fund and their bond position will be 100% in a bond index fund has probably the winning strategy.
Why aren't more people paying attention?
One, they're much more focused on the short term. They don't look at the implications of cost and tax efficiency over the long term. No. 2, for financial-services firms, the marketing of products is a very powerful force. No. 3, there are always some funds that do better than the index. What else is new? We beat the average fund every day, every hour, and every minute, as I say in the book. But there's always someone that does better.
Do you think the growing popularity of exchange-traded funds presents risks to investors?
Of course it does. ETF is a term that covers a multitude of investment strategies. Something like the Vanguard Total Stock Market ETF (VTI) is every bit as good bought and held as buying the Vanguard 500 (VFINX) or Vanguard Total Stock Market (VTSMX). There's really not much difference.
The problem is that ETFs are not competing with index funds—they are index funds. They're just index funds that can be traded. I would ask what kind of a nut would want to do that.
Basically, the ETF business has become driven by an unholy alliance of fund marketers, fund entrepreneurs, and brokers who figured out that the public isn't satisfied with indexing. It's a little bit dull. So we now offer all kinds of strategies, like highly leveraged strategies, long strategies, short strategies for particular industry groups.
The most popular are those that have done well recently. There's a lot of performance chasing in gold ETFs, commodity ETFs, or emerging-market ETFs.
It's easy to sell something that's doing well. Investors have much more self-confidence than they should about their ability to select managers. We all think we're above-average drivers. I've observed that most people think they're above-average lovers, but we're all average.
You've praised the growing number of low-cost index funds, but are they all really the same? Are there any problems with tracking?
There are not very many significant problems with tracking as far as I can tell, at least with respect to the broad market indexes.
When you get to a commodity index or a gold index or a very narrow specialty index, there aren't problems with tracking. But what differentiates the classic index funds by a huge amount is the costs they incur.
You recently said that you think investors should diversify into international stocks a bit. Where should they look and how does this fit your core philosophy?
Let me first say I didn't quite say they should. I said it's probably a little more likely that they'll do better. I worry increasingly about the problems we face here in the U.S.: excessive borrowing, huge federal deficits, our role in the world, financing these incredibly costly wars—up in the trillion-dollar range—the pension system that's underfinanced, and now retirement-time health care. And I also worry about the strength of the dollar.
I should say that I do very little international investing. I'm thinking about doing it, but I'm kind of scared about being one of these performance chasers. So I advised people in the Wall Street Journal article to do it gradually over a number of years. If this turns out to be a peak period, you won't be badly hurt. I don't like precipitous moves—I'm a conservative person.
You should realize that U.S. companies are international companies. Around 35% of the revenues and earnings of the companies in the S&P 500 come from abroad.
If you want to invest internationally, it is crystal clear that you want an all-market international index fund. This is not because of any magic, but it's those same relentless rules of humble arithmetic.
Indexing works better in international markets than it does in the U.S. for one simple reason: Costs are higher in international markets. The countries that dominate the international index are not all that different from the U.S. You're getting something that may prove to be, forgetting the dollar for a moment, pretty much parallel those in the U.S.
So I recommend that instead of having an international portfolio of up to 20% of your equity holdings, put 10% in total international and 10% in emerging markets. Now they're very risky, but if you're 70% in stocks, that would give you 7% in emerging markets. That may not work out well, but it's not going to destroy you.
What do you see as a model index asset allocation for, say, a 30-year-old single man?
I've used a rule of thumb that I modify a little bit. I used to say your bond position should equal your age, so that 30-year-old would have 30% in bonds. I now say your age less 10 years.
It's a little more aggressive because we can be reasonably confident that stocks will perform better than bonds over the course of an investment lifetime. I'm leaving out costs here, but in this industry we fail to pay attention to costs. If stocks do 2.5% better than bonds, most investors are going to use that up in expenses, and God knows how much more they will lose in emotions.
What's next for you?
I'm fond of telling people that I am going to retire—I just have no idea when.