30 for 30 Interviews: John Bogle

That has to change. That’s not going to be easy to do. My god, if we can’t even get a consumer protection bureau, how you’re ever going to get a federal standard of fiduciary duty is something that most people would say is not entirely realistic. I’m idealistic enough to say that the more people tell me it’s not going to happen, the more I’m absolutely determined to fight on.

The other solution, let’s call that the ethical principles solution. The other is the Adam Smith principle solution and that is if investors would only look intelligently after their own interest, would only look after themselves, all of this would happen because they would buy index funds and in an 8% market shareholders are going to get 5.5%, there’s no way around that, so the index fund will give you 8% less 10 basis points, or maybe 15. So it will capture your fair share of the market returns. Investors have to be educated. You don’t have to trade index funds. The managers don’t trade anything. The investors can’t be disappointed in the managers because they’re just capturing the market returns. It’s the simplest solution in the world. It’s growing, but it’s still only up to about 20% of mutual equity fund assets. So we have a long, long way to go.

If investors march in that direction, other firms will have to consider: a. a structure like Vanguard’s in which the shareholders do come first because they own this firm, they’ll also have to consider if they don’t want to do the structure, of behaving more in a fiduciary mode and that is investing for the long term, having a portfolio…this industry was primarily run by investment committees, teams of trustees, and we seemed to do better back then than when we got into this wild age of the portfolio manager–here the name was not to do a good job for investors but to take big risks and if they pay off, god how the money will roll in.

Most people totally disagree with me, but I’d love to take somebody on and just challenge them on every sentence that I’ve just uttered. Is it true that gross returns in the market minus the cost of investing or the net returns investors receive as a group, if somebody wants to argue that position they’d be laughed off the stage. It’s not a good position to say that the mathematical reality does not exist.

How important is shareholder activism for index funds?

The old so-called Wall Street rule is if you don’t like the management, sell the stock, and it’s a pretty crummy rule anyway. It doesn’t stand the test of reason or analysis, but index funds cannot do that. So they have to say if we don’t like the management, change the management. This is not a revolutionary idea. Benjamin Graham talked about it, not from the mutual fund standpoint when funds were so small but from the standpoint of investors in corporations. He was doggedly pursuing greater activism by shareholders. Back in the first edition of The Intelligent Investor, back in 1949, probably 30%, certainly 25% of the book was dedicated to shareholder activism, now long forgotten. So to the extent that Benjamin Graham is the towering ideal of our age, and he remains that way to me, what I’m talking about is basic Benjamin Grahamism, not communism, or socialism, or revolution, although I do say investors of the world unite to get these things done in corporate America.

What do we need to do to prevent another crisis like the one we’ve just been through?

First there’s the fundamental nature of the crisis, which is too much debt at too low a quality, too much leverage, too much innovation. In the financial business innovation is designed to serve marketers and not investors. Let’s see what we can figure out here so we can sell something to somebody. You see it in the mutual fund industry, you see it in the credit default swaps; you see it in collateralized debt obligations. So we need less innovation, so we have to reward innovation less and part of it is we have to have less leverage. I think that as a matter of public policy we ought to be considering reducing and maybe even eliminating the tax deductibility of interest. One of the big underlying problems, which not a lot of people have talked about, is the extreme attractiveness of debt compared to equity, which led us into a lot of the problems with private equity, into a lot of the problems with hedge funds, a lot of the problems with investment banks–too much debt, too much leverage and poor quality in the balance sheets. The analysts, I think, the professional security analysts, the buy side analysts, ought to be thinking about doing a much better job. Someone like Peter Fisher from Black Rock, a man I greatly respect has suggested you need a special license to be an analyst of bank stocks. I don’t think that’s a bad idea, because that’s a complex piece of work. But we have to do a much better job of analysis and my god, the accountants have a lot to answer for in all of this, and the ratings agencies have a lot to answer for in all of this. At our fixed income meetings here years and years ago when we started the fixed income group, I would sit in on all the meetings and someone would say, these are rated AAA by Standard and Poor’s and Moody’s and I would say I don’t care what they’re rated by Standard and Poor’s and Moody’s, what do you rate them?

People seem to constantly do things that are illogical, or against what appears to be their best interests. Is that just human nature?

There’s a gambling mentality in all of this. They want investing to be fun and investing should not be fun. Investing should be boring. You should buy and hold a portfolio of stocks and bonds weighted in various ways and hold it for your investment lifetime. What I tell people is one of the best rules is don’t peek.

An index fund is going to give you that market return. America’s future particularly in this day and age, I want to be very clear about this, is not guaranteed, but it’s the best thing we have available to us out there, I think. A little international diversification, even though half of the revenues and profits of American companies come from abroad, a little international diversification in stocks that are headquartered outside the U.S. is not I think necessary, but it’s not a foolish thing to do, 20% of the equity portfolio could be in developed and emerging markets around the world, and you want to be very clear in your allocation. People that thought the market was an endless ride of 9% returns without any bumps made a big mistake, so they panicked and they should have been much more careful about their asset allocation, they should have been more cautious.

I’ve often said the best rule in investing is not, “just don’t stand there, do something,” because that’s the way the financial business works, that’s when your broker calls you up, or your mutual fund advisor calls you up, and says, “I guess you heard what happened yesterday, you better do something.” A better rule is “don’t do something, just stand there.”

We all think we’re smarter than average, better drivers than average, I’ve observed without factual verification that most people think they’re better lovers than average, and they think they’re better managers, because “I can pick good managers.” The record is bereft of a single scintilla of evidence that’s an easy thing to do. In fact French and Faema in their most recent publication juszt a few weeks ago said the chances that a mutual fund will beat the market over a long period of years is 3%. The odds are 97% that you’ll do worse than in an index fund. So I’d just like to bring common sense, reality and mathematical truth back into the world of investing. And don’t think I’m going to stop trying.

Do you have any advice for our audience?

The basic piece of advice is put the client first, not only in letter but in spirit. Look to the long term. Look to the wisdom of long term investing and as far as possible from the folly of short-term speculation. The idea is to capture the returns of the bond and stock markets. Don’t reach for yield. Don’t reach for performance. Those things generally have unhappy, even tragic outcomes. Invest the money of your clients’ the way you would invest your own. By the way I have a new convert to this philosophy and his name is Bernard Madoff. There was an article in the press somewhere that said all the convicts down in his prison are asking him for investment advice and he’s telling them all to buy index funds.