INTERVIEW
The Reality Of Investing
John C. Bogle Of Vanguard
by John Sweeney
John C. Bogle, president of Bogle Financial Markets Research Center, founded The Vanguard Group, Inc., in 1974, after having been associated with a predecessor company since 1951. The Vanguard Group is one of the largest mutual fund organizations in the world, with more than 100 mutual funds with current assets totaling more than $550 billion. In 1975, Bogle founded Vanguard 500 Index Fund, currently the largest fund in the group. It was the first index mutual fund.
Bogle is the author of two best-selling investment books. His third book, John Bogle On Investing: The First 50 Years, will be published by McGraw-Hill late in 2000.
Bogle's philosophy of investing is the antithesis of the typical trader's, so we figured we'd get an earful talking to him. We weren't disappointed! STOCKS & COMMODITIES Interim Editor John Sweeney spoke with Bogle via telephone on August 29, 2000.
ILLUSTRATION BY CARL GREEN
Given that you are going to be read by traders in this interview, I was just wondering -- are there any traders in your organization at all?
Not for our index funds, but we have, obviously, desks of people investing cash as it comes in, and therefore buying stocks and selling stocks, and bonds for that matter, as cash goes out. Our managed stock funds are very low-turnover funds. And the municipal bond funds and money market funds -- well, money market funds turn regularly -- are also quite low turnover. So we don't have anyone engaged in trying to outtrade the market, if that's what you use trading for.
Is that the secret to holding costs down? Not having to pay hundreds of thousands of dollars to somebody to outguess the market?
Well, I guess there are really four sources for holding the costs down. One is holding down a fund's operating cost. The amount of management fees that a fund pays is a big part of that, and of course we operate at cost anyway, so we do not normally pay fees. There is no profit to an outside firm with the things we are doing here. So our job is keeping the operating cost of the fund, the expense ratio of the fund, at the absolute rock-bottom level.
You operate at cost? You still have to pay people. You still have to have computers. You still have to have the legal disclosures.
Sure, but we operate Vanguard at a budget of close to $1.5 billion a year, and that is about 27 basis points on $580 billion. Those costs are apportioned among the funds, basically in relation to their net assets (Figure 1). So if a fund is 7% of our net assets, it would pick up 7% of those costs. But there is no premium in there. It is just cost. We all get paid, yes. This is not sackcloth and ashes.
FIGURE 1: COSTS OF FUNDS. Costs are apportioned among the funds, basically in relation to their net assets. Note the comparison between managed funds and index funds.
You are getting paid market rates? Your people are not getting less than anybody else, are they?
No, and I am doing just fine. We have a very nice incentive plan in which we are all rewarded in cash terms. There are no options or anything of that sort because there is no stock. Even so, we have the ability to have costs substantially below the levels of our competitors and outperform our competitive groups. So each year, we go through this cycle in our incentive pay. We are paid market rates, or probably less than market rates for senior management, because the incentives for the vast body of the company are market rates plus your share of this incentive plan, which is called the Vanguard Partnership Plan.
But the rest of us have an incentive based on our ability to keep cost below the competitors. For example, if we can operate at, say, 25 basis points and the competition operates at 105 basis points, we save 80 basis points. And if you save that on almost $600 billion, that is a savings to the shareholders of $4.8 billion a year. That is about what we save them. And a very small portion of that is put into this incentive plan.
What else?
Second, each of our funds is evaluated yearly on the basis of its performance over the past three years, whether it is above average in its competitive group -- say, growth and income funds, or value funds if you will, or small-cap growth funds, or intermediate-term municipal bond funds. Each fund is awarded a rating -- average, above average, or below average -- for its performance relative to its peers and relative to market indices. That is usually about 20% of the incentive award. Because we are able to outperform -- not uniformly, nobody does that -- it probably contributes 20% to that total pool.
That is the at-cost part. It does include incentives. They are nothing like the incentives we would have if, for example, I owned Vanguard. I suppose I would be worth $10 billion. Well, to say my net worth is 1% of that would be too high. We are all comfortable with that. It is the system I set up 25 years ago, so I am happy with it. It works very well for the shareholders, who are the people we are supposed to serve.
The second cost is portfolio turnover. That is a detraction from returns.
Is that just from transaction cost, or is that also tax cost?
That is just transaction cost. I am talking about the investment cost attendant to trading securities. That includes commissions, bid and ask spreads, block positioning cost, and the like. To the extent you can keep that down, you can minimize those costs.
Excerpted from an article originally published in the November 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.