Minding Bogle : ‘Index’-Investing Pioneer Believes, Now More Than Ever, in Keeping It Simple

As senior chairman of Vanguard Group, John C. Bogle has long been one of the nation’s chief spokesmen for the technique of “index,” or “passive,” investing. Vanguard has pioneered the marketing of indexed mutual funds to investors--designed to match benchmarks such as the S&P; 500 stock list--by emphasizing their low transaction costs, minimal fees and consistent success in outperforming the actively managed funds that dominate most investors’ portfolios. Bogle will be the featured speaker at Saturday’s early general session (8:30 to 10:15 a.m.) of the Los Angeles Times Investment Strategies Conference. He was interviewed by phone from his firm’s Malvern, Pa. offices.

Times: As a keynote speaker, what are the major lessons you’re going to be offering the participants?

Bogle: The title I’m considering for my talk is “Simplicity: Key to Investing in a Complex World.” The issue is that the world is getting more and more complicated, so what the heck does an investor do with all this information, what with computers and everything happening with the speed of light. And my message is that the more complex the world around [us] gets, the more simplicity we ought to seek to realize our financial goals.

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Times: How does that translate into a specific investment strategy?

Bogle: The threshold issue is, what is investing all about? The answer is, getting as much return out of the market, whatever market you’re investing in. Now, in fact, for investors as a group it’s a mathematical impossibility to beat the market. That is to say, all investors together own the market, so they will all get exactly the same return as a group. But they will pay costs.

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Times: What are the most important costs for investors to watch out for?

Bogle: Well, they’ll pay very high costs of mutual fund ownership, for example. They may pay sales charges, and all funds have expense ratios--and high ratios in the case of some funds. The funds will have transaction costs because they [the managers] are extremely active investors. So fund investors should fall around 2 percentage points short of the market each year [on average]. The challenge for the investor is to earn the highest returns that are realistically possible.

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Times: You’re saying the way to do that is through the simplest approach.

Bogle: Absolutely. And the simplest of all approaches is to buy an index fund that is, let’s say for the purposes of argument, 65% in stocks and 35% in bonds.

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Times: Now, obviously, over the long term, as you’ve said, the index funds will outperform most actively managed funds. But haven’t there been periods in which something can go wrong?

Bogle: What can go wrong is nothing, but what can appear to go wrong is that a certain subset of advisors--let’s say mutual fund advisors, for the purposes of argument--have all the brains and smarts in this business. There’s nothing in the record that suggests that’s the truth.

Today mutual-fund-related accounts amount to 33% of all stock. It is simply unreasonable and ridiculous to suppose that as a class of investor, only one-third of the market can outpace the market.

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Times: Then why do you think that among institutional investors and even among individual investors there isn’t a broader acceptance of these realities?

Bogle: First, it’s counterintuitive to believe that “no management” can beat “management.” Think about that for a minute. Imagine approaching a stranger on the street and telling him, “If you just don’t manage your money you’ll do better than if you do manage it.” The next thing is that hope springs eternal. A person thinks, “I know what the record shows, I know what the past is, but in the future I can do better.”

The third reason--and this is a very important one--is that there is no economic incentive for the vendors in this business, the fund managers, to sell an index fund. Why? Because you can’t make any money on an index fund for yourself. The index has a big problem--it can only make money for its investors, not for its sponsors.

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Times: How else will you be advising people to put simplicity to work?

Bogle: First of all, I caution them against owning too many funds.

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Times: How many is too many?

Bogle: Well, of course, the fact is you only need one--that balanced index fund. But five funds is probably about enough.

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Times: Are we talking about five funds representing different sectors of the market?

Bogle: Yes. Maybe a large-cap value fund and a small-cap growth fund and a mid-cap fund of some kind, a specialty fund and perhaps--and I underscore “perhaps” here--an international fund, because I’m not confident in my own mind that international is the way to go.

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Times: For the average investor, is it possible to manage your assets actively within the index universe by adjusting the allocation of your money within these four or five categories or by moving in and out of the market as a whole?

Bogle: Well, one of my rules is not to engage in market-timing. The burden comes down to not only getting out of the market at the right time. Even if that’s easy, getting back in at the right time is difficult. So you’ve got to be right twice. And it’s not so easy being right twice, because human beings are emotional. At the market high they are optimistic. Every bone in their body tells them not to get out. And at the market low they are scared to death, and every bone in their body, every fiber of their being, tells them to get out, just when they’re supposed to get in. It’s a lot to ask of a human being.

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Times: You expressed some doubts about international funds. Why is that?

Bogle: When international stocks were good back in the early ‘90s, they were good somewhat because the dollar was weak, and that helps international returns for U.S. investors. But the dollar will equalize a currency over an extended period. So the only assumption that I think you can use in buying international securities is the dollar will be about the same five or 10 years from now as it is today.

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Times: How does that affect the calculation of returns?

Bogle: There was a time maybe three years ago when the S&P; index was up something like 12% a year, and the international index was up 16% a year. So there was great cheering for international. It’s a big difference in compound return.

But if you looked at the returns in local currency terms, ignoring the change in the dollar, the international index was doing 8% a year, not 16%, compared to the U.S. market’s 12%.

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Times: One last issue we should discuss is the sustainability of what’s known as the “new paradigm”--the theory that we’re in the midst of a trend of long-term individual investing for retirement as well as a surge in worker productivity that will buoy the markets indefinitely. How do you feel about that?

Bogle: Well, I look at it in two respects. One: Is the retirement plan money--401(k) money and IRA money and qualified-plan money--is that a basic fundamental trend? I would say absolutely. I don’t think money is going to come out of those plans unless we have the kind of a recession that, as one wise man said, would curl your hair.

But I do think that individuals are human beings. Emotions come into this, and I can easily foresee that if you get scared to death about the stock market because it goes down 25%, if you get really frightened about that when you go for a little more safety, you will go not only with your regular investment account, but also your retirement investment account. It’s hard for me to see an investor saying, “I’m going to get out of those mutual funds that I hold directly but keep the funds I own in my retirement plan.” Actually, he’d do the exact reverse.

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Times: Why is that?

Bogle: Because if he’s going to have a split personality, he’ll get out and get back into the funds he can without a tax event, the funds in his retirement plan account.