John C. Bogle, who founded Vanguard Group and revolutionized the way millions of Americans save and invest, died on Wednesday.
He was 89 years old.
Bogle's best-known legacy is the index fund, a low-cost, diversified way to hold stocks or bonds. In an unpredictable market, few investment managers are able to consistently leave their customers, rather than themselves, better off. Jack Bogle could be said to be an exception: Compared to traditionally managed funds, index mutual funds as group save their owners billions per year in the fees deducted from returns.
And index funds, tracking broad market benchmarks, generally outperform more-expensive “active” managers.
A Counterintuitive Idea
In 1976, Bogle’s Vanguard Group launched First Index Investment Trust, now known as Vanguard 500 Index. It was the first retail mutual fund of its kind. It didn’t employ a manager who tried to pick the best stocks, or to guess the right time to get into or out of the market. Instead, First Index aimed only to replicate the average performance of the blue-chip stocks listed on the Standard & Poor’s 500 index. This was a counterintuitive idea, and in fact it was challenging to pull off: At first, the fund only had enough assets to buy about 280 of the index’s 500 stocks, Bogle later wrote. And the small Philadelphia company running it was less than two years old, with a boss—Bogle—who had been fired from his previous job. "When Vanguard started, it was a very risky kind of thing," recalled Bogle in an interview with Money speaking of the early prospects for his company.
The index fund wasn’t Bogle’s invention—a few funds running money for institutions and pensions got there first--but First Index made it accessible to individuals with relatively small amounts to put into the market. (The minimum investment was only about $6,000 in today's dollars.) Its costs would be low, at 0.4% per year early on compared with the 1.5% others charged. Still, despite immediate praise from the likes of Nobel-prize winning economist Paul Samuelson, it was slow to catch on. As Bogle liked to point out, his fund literally had no competition in indexing for about eight years.
By the 1990s, though, investors started to notice. For a time, simply by tracking a rallying bull market, the 500 fund was beating the majority of fund managers by such wide margins that Bogle had to warn investors not to expect the fund to win every year. The issue came up again after 2014. “Index funds had a fabulous year last year. It’s not going to happen again, maybe ever,” said Bogle in an interview with Money published in 2015. “You shouldn’t buy an index fund because you think it’s a hot performer. Buy it because you’re going to hold it forever.” Indexing wins not because of some magic formula, but simply because, as Bogle often explained, the average active fund manager over time is likely to match the market’s average--and then trail it after charging investors fees.
Vanguard is now a giant asset manager, with over $5 trillion in customer accounts. Its Total Stock Market index fund, a broader portfolio which includes smaller companies in addition to blue chips, has over $600 billion in assets as of January. As a group, index funds are nearly half of the assets held in U.S. stock mutual funds, and they are a staple of 401(k) retirement plans. Little wonder: According to a 2018 report fund researcher Morningstar, only about one in three active stock fund managers managed to outperform comparable index funds over the previous twelve months.
“In nautical terms, a high-cost fund is sailing into a hurricane,” said Bogle, who dubbed Vanguard employees its crew, and named the company after one of Admiral Horatio Nelson’s flagships.
Bogle retired as Vanguard’s CEO in 1996, but maintained an office at the company’s suburban Philadelphia campus and a busy writing and speaking schedule. His zeal for plugging the virtues of indexing and low-cost investing—and his attacks on other managers’ fees—earned him the (sometimes grudging) nickname “Saint Jack.”
But if the index fund was Bogle's triumph, it was not the biggest thing he had hoped to accomplish. In fact, in Bogle’s own account, he first launched the index fund in part because it provided a contractual loophole. The Vanguard Group was born out of a battle for control for the Wellington family of mutual funds. Bogle had been fired as CEO of Wellington Management Company in 1974, but then convinced the directors of the funds to let his new company take over the back-office administration. Vanguard wasn’t supposed to manage any money on its own--but Bogle launched the index fund arguing that indexing didn’t count as managing money. The fund wasn’t picking stocks, after all. “Disingenuous, let’s call it,” he said. “But true.”
Much more important than indexing to Bogle was the Vanguard Group’s business structure. The company was owned, indirectly, by its own clients, the mutual fund shareholders. It was, and remains, an unusual way to run a fund company. “Where the hell are the other Vanguards?” Bogle would ask. “We’ve yet to find our first follower.”
Bogle’s design for Vanguard was based on a deeply critical, even angry, view of the financial-services business. He pointed to how the profit motive at most fund companies could put their interests in conflict with those of fund buyers. “This is a marketing, profit-making and profit-seeking business,” he said, “in which the game is to maximize return on the manager’s capital, not the investor’s capital.”
A typical management company must earn profits for its owners or corporate stockholders by collecting an annual percentage of each fund’s assets, reducing the returns left over for fund investors. “This great asset-gathering machine known as the fund industry wants to maximize assets under management, the better to maximize their revenues,” said Bogle. “There is no incentive to share those margins with fund shareholders.” He frequently called management fees “the croupier’s rake,” or the house’s cut at the casino. It’s the rake, and not necessarily market-beating investment acumen, that fuels money managers’ rich earnings.
The Vanguard Group is owned by Vanguard’s mutual funds, which in turn are owned by the funds’ shareholders. So in contrast to most fund companies, the interest of the company’s ultimate owners is for funds to be run at lower fees–or as Vanguard puts it, “at cost.” This does not mean Vanguard is run like a charity. “At cost” includes compensation for the company’s executives, as well as fund managers and analysts, who the company has said are paid competitively, though it does not disclose salaries. In 2006, Bogle confirmed to the Boston Globe earlier reported estimates that he made about $2.5 million in at least one year in the early 1990s.
In 2015, Bogle conceded that if he had a chance to design the company again, “I would have made it mandatory that we continue to disclose executive compensation.” He added: “I think openness is important if you’re a company like Vanguard because these people own not only your funds but the management company too.”
Vanguard’s employee compensation formula, as described by Bogle biographer Lewis Braham, effectively grows the bonus pool as assets under management rise, and the company has not turned away from the chase for investor dollars. For example, it expanded successfully into offering exchange-traded funds, a wildly popular new kind of index fund that can be traded instantly like a stock. Bogle himself was not a fan of ETFs, and often warned that they encourage people to make speculative short-term trades. “It’s great for financial buccaneers,” he said. “But I believe… it’s not great for investors. (Still, he would also say that basic ETFs could work as well as regular index funds, as long as an investor held them for the long-term.)
Keeping Costs Down
But even after Bogle’s departure, Vanguard has in fact kept its costs low. According to the company, its average expense ratio is 0.11%, compared with just over 0.6% for the industry. That’s not just because of index funds: Vanguard runs a number of popular active funds, including the original Wellington fund, priced at 0.25%.
Costs may seem a persnickety worry, but Bogle understood how tiny-looking, tenths-of-percentage-point differences in fees added up. The standard practice of pricing funds in small percentages of a big number, instead of in dollars, makes it hard to see the real cost. “We have the miracle of compounding returns overwhelmed by the tyranny of compounding costs,” he said.
In fact, paying 1% for $100,000 in a fund costs $1000 in only the first year. And over 30 years, it consumes 26% of your potential wealth, assuming the fund’s return before fees matches the market, compared with 6% if you pay just 0.2%. It also obscures the large fee revenues companies can take in at investors’ expense. “The whole cost structure of this industry is insane,” he said, pointing to profit margins near 50% for some money managers. “The returns on capital are for the owners of the management company. They’re huge.”
Costs can also distort investment decision-making. They may drive both retail fund investors and fund managers to take on more risk, as they reach for higher returns to overcome the burden of costs. Bogle once calculated that a 50% stock/50% bond portfolio with low expenses would have the same expected returns as a riskier 65% stock/35% bond allocation with very high-cost mutual funds. “Asset allocation and costs are tied together,” he said.
Fund companies’ hunger for assets and fees has driven waves of faddish products, from Internet funds to esoteric bond strategies to ETFs that use high-risk leverage to deliver twice the returns of the S&P during bull runs. It also contributed to the rise of celebrity fund managers, whose returns can be touted in advertising and in the press (which fund companies aggressively court) when they hit a hot streak. But in his popular personal finance books, including Common Sense on Mutual Funds and Bogle on Mutual Funds, Bogle used industry data to show that very few funds are able maintain outperformance for long.
“What we wanted from the very beginning,” Bogle recalled, “even before the first index fund started, I said ‘We want funds with relative predictability. Don’t give anyone a wonderful surprise on the upside and don’t give anyone bad surprises on the downside.’” That thinking grew partly out of his own experience running the Wellington fund company, when by his own account, he allowed it to chase the “Go-Go” bull market of the late 1960s, with badly disappointing results.
Crusader for Investors
Bogle’s long career coincided with the explosive growth in the money management industry. He wrote his Princeton University senior thesis on the fund industry in 1951, when it ran about $3 billion. Funds now have $18 trillion under management and, with the decline in traditional pensions, have become a cornerstone Americans’ retirement. But Bogle noted with frustration that average expense ratio generally rose as the industry grew, instead of being cut down by competition. (They did finally begin to decline after 2000, thanks in part to index funds.) “We thought mutual fund managers would be able to do better, and I think they let us down badly,” said Bogle.
After 2000--and especially in the wake of the 2008 financial crisis--Bogle expanded his criticism of the fund industry to corporate America at large. He saw CEOs increasingly aiming only to please short-term shareholders--often fund managers looking for quick returns. “We’ve had quite enough speculation and not enough investment,” he said. Bogle worried that the rise of funds as intermediaries meant that few investors felt the responsibilities of a business owner. “The way I calculate it, 99% of what we do in this industry is people trading with one another, with a gain only to the middleman,” said Bogle in 2015.
Bogle was not an activist but an entrepreneur. He could say that “I think capitalism has failed us the broader sense, and I think capitalism has to change.” Yet he still believed that efficiently-managed, low-cost funds could give investors and savers what he called their “fair share” in the growth of public companies. Jack Bogle did not think very highly of the financial industry; ironically, that’s what helped him to recognize and popularize one of finance’s best ideas.