-- John Bogle is the founder of the Vanguard Group, one of the nation's largest mutual fund complexes. He created the Vanguard 500 Index fund, the first fund that jettisons the fund manager and tracks a stock index — a low-cost, tax-efficient way to invest that has been embraced by institutions and individuals alike.
An outspoken critic of the mutual fund industry, Bogle has written several no-nonsense books about how to invest, including Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor (1999) and Bogle on Mutual funds: New Perspectives for the Intelligent Investor (1993). His latest book, The Clash of the Cultures: Investment vs. Speculation, came out in August. In this interview, Bogle shares his views on exchange-traded funds, fiduciary standards, indexing and money market mutual funds.
Q. Speaking of speculation, have exchange-traded funds gotten out of hand?
A. No question about that. It's typical of what happens when you have marketing people instead of investment fiduciaries running money. You have marketing entrepreneurs getting into a fast-growing business. It's a way to get into the fund business. The ETF is the magic word of the day, the greatest marking innovation of the 21st century. But the data shows an awful lot of ETF trading, a huge amount every day. The Spider (SPDR 500 index; ticker: SPY) is the most actively traded stock.
It's absolute speculation, and it's hurt a lot of people. Vanguard ETFs have the same fees as regular index funds, and they're cheaper than anyone else's. People say if you own the S&P 500 index in the ETF form and never trade it, how can you object to it? But the temptation is there.
Q. How much more likely are you to trade ETFs?
A. Vanguard did exhaustive study on ETF use and ignored that point. You're probably 25% more likely to trade with an ETF. It's not day and night, but the trend exists. And these are the Vanguard experiences; others are certainly worse.
Q. Do investment advisers trade as much as individual investors?
What advisers have to do is respond to events. Activity is something investors expect. I was talking about buy and hold to some investment advisers, and one said, "I tell my investors to do this, and the next year, they ask what they should do, and I say, do nothing, and the third year, I say do nothing. The investor says, 'Every year, you tell me to do nothing. What do I need you for?'" And I told them, "You need me to keep you from doing anything."
Q. You've long urged that brokers be put under fiduciary standards. Have you heard a convincing argument against it?
I think it's less of posing an argument against it than it is saying that the brokerage industry thinks it's better off under FINRA standards, which is the suitability suitability standard. At a brokerage firm, a broker has to sell investments, and all he has to do is prove the investment is suitable. But if your job is to manage people's money, the fiduciary duty is so clear, so obvious.
Where it gets really interesting and difficult is the mix between life insurance and annuities. If a salesman discloses being a salesman, that's a responsible position. To a regular life insurance salesman, the only things that matter are soundness of the issuer and the cost. But if you work for Met Life, you won't recommend Northwestern Mutual, which is one of the lower-cost insurers. But the issue of cost is never taken on. I've helped a little about this: The magic of compounding returns overwhelmed by tyranny of compounding of cost.
Q: What do you make of broad-based index funds that take a different approach to indexing, such as those that give each stock in the S&P 500 an equal weight?
A. It doesn't do anything for me. If you invest in the Vanguard 500 Index fund ( VIFSX) or the Vanguard Total Stock Market fund ( VTI), you're absolutely guaranteed to get a fair share of what the market delivers. An equal-weighted S&P 500 fund will do better or worse and in its own way is a form of speculation. And funds that invest in commodities and currencies — that's clearly just big speculation. An investment has a rate of return, such as dividend yield and earnings growth. There's no such underpinning in commodities and currencies. It's absolute speculation.
Q. A number of commodity-based ETFs aren't covered by the Investment Company Act of 1940, which regulates most mutual funds, and so don't have the same protections that most funds do. Do you think investors understand that?
A. Less than 1% understand that. The same is true with exchange-traded notes, which are credit notes. Investors should invest and not speculate.
Q. What worries you most going forward?
A. The coming train wreck in the financial system. A 401(k) is a thrift plan trying to be a retirement plan. It was never designed to be a retirement. To be a retirement plan, you have to keep putting money in and can't be allowed to take money out, and you can't be allowed to borrow from it. And if you change jobs, you should be able to take it with you to your new job. The reality is that probably 70% of the citizens of this country will rely entirely on Social Security.
Q. How significant a risk do you think money funds pose to the overall financial system?
A. It's hard for me to put in the context of the overall economy. It's certainly one of the major risks in the mutual fund industry. There's this kind of razor's edge, and all of a sudden you go over it, and people suddenly want their money at the previous price. It's just not sound.
Q. The expectation that you can always get at least a dollar back for each dollar invested is a key reason why money funds are appealing to investors. What will happen if a floating standard is established?
A: The asset values already float, but we just hide it. There is not the kind of safety that people assume there is. I know this would be painful for the money market industry to move to a floating NAV (net asset value), but it would not eliminate the industry. That's absurd. I don't think enough people are standing back and saying, "What's the reality here?"
Q. The industry is already challenged because money fund returns are currently tiny, and investors have been pulling cash out as a result. Returns have recently averaged 0.02% — $2 a year for each $10,000 invested. Might tighter restrictions make things worse?
A. The industry isn't providing a competitive return now, but that will change over time. If there is a floating net asset value, people will understand that asset values do float, if only a tiny bit. And if a company runs a money fund very conservatively, you can still keep the asset value stable every day of the year.
But there's always the chance of something going wrong in this technology-driven system. After what happened in 2008, we now know that there's an immediate contagion if something happens to a money-market fund. Even though only one of the funds gets pneumonia, every money fund gets a cold.