Remarks by John C. Bogle, Founder, The Vanguard
Before the Society for Information Management
February 2, 2000
It's wonderful for this close observer of the rapidly changing
world of technology to be with this group of distinguished investment technology
professionals tonight. I want to discuss with you, first, a bit of Vanguard's
history, as we grew from a technology follower
in the financial services arena to the technology leader.
But I also want to discuss the impact of technology on the mutual fund industry,
and specifically whether it is a bane or a blessing. Clearly, information
technology has brought our world into a new era, as the availability of information
and the speed and ease of communications soars to levels beyond what any of
usor at least myselfwould have even found imaginable as recently
as 15 years ago.
In my case, I can make that statement with considerable authority. For
in September 1985, a reporter for Forbes
magazine asked me how I viewed the priority that tiny Vanguardthen
with $10 billion of assets, just 1/53rd of our present $530 billion asset
sizewould place on technology. "We are not going
to be a technology leader," I said, and was duly quoted in the
article that appeared later that month. "We cannot afford
Considering the circumstances at that time, it was not quite as stupid
a comment as it might seem today. For, then as now, we were extremely cost-conscious,
driving as hard as we could to become the lowest-cost provider of financial
services in the world. We sought that goal, not because it would be an advantage
in marketing (although it would prove to be just that), but because, as the
only truly mutual mutual fund organizationuniquely,
Vanguard shareholders own both the funds and
the company that operates themwe knew that every dollar of costs we
saved would provide an extra dollar in the returns we delivered to our fund
investors. (By 1999, the 100 basis point [1%] difference between Vanguard's
unit costs and the fund industry norm would put an extra $5
billion in our shareholders' pockets.)
The First Leap Forward
Despite that philosophy and despite my callow words to Forbes,
within a year we took our first aggressive steps to expand our technology
commitment. Bob DiStefanothen and now Vanguard's technology boss, and
for my money, one of the most capable technology executives in the financial
services fieldreminds me that in mid-1986 I urged him to step a bit
more lightly on our cost-control brake and more heavily on the accelerator
that drove our then-modest technology program. While the numbers seem puny
by today's standards, we quickly upped the number of programmers two-and-a-half
foldfrom 22 to 56and our total tech staff to 75. We have been
building our technology focus and commitment ever since.
In those days, our world was fairly simple: Each shareholder in each
fund got a regular quarterly statement from each fund independently, just
as if he or she owned, say, one Vanguard fund, one Fidelity fund, and one
T. Rowe Price fund. With some 700,000 shareholders on our booksmost
of whom owned but a single fundthat was "industry standard" at the
time. But the standard was about to change, and our commitment to expand our
technology effort came not a moment too soon.
Our business not only grew by leaps and bounds, but at ever-increasing
levels of activity and complexity. Today, with some eight million
shareholders on our books, Vanguard has become the second largest mutual fund
organization on the face of the globe. Most own at least two Vanguard funds,
and many own five, six, seven, or more. Through the miracle of technology,
they now receive a single combined statement
for all of them, in the mail or, for the many who have elected to skip the
paper, electronically. Some two million of those shareholders own Vanguard
funds in their 401(k) corporate retirement plans, along with hundreds of thousands
who own our funds through our variable annuities, or our brokerage affiliate,
or our defined benefit administration, or our asset management and trust division,
so we actually must maintain six separate
record-keeping systems. Nonetheless, today our shareholders can view an electronic
statement that combines all of their accounts
through our "Access Vanguard" website, which receives
hundreds of thousands of visits each day. This is a remarkable and valuable
service and a big cost saver as well.
The Next Leap Forward
Getting to the here of 2000 from the there of 1985 was not easy. I think (and Bob DiStefano
agrees with me) that the major turning point came in 1992, with the delivery
of my "Sacred Cow" speech at our executive meeting in midyear. In it, I announced
that my somewhat heavy-handed, Luddite-type approach to our business could,
in a rapidly changing New World, retard our progress. I presented the staff
with a list of seven Vanguard business principlesI called them sacred
cowsthat the officers felt, probably reading me correctly, we would
never violate. I told them that those principles that involved our basic investment
philosophy and our fundamental human values indeed were
sacred, but that other policies would have to be killed if we were to remain
competitive. By the time my speech was over, four of the sacred cows were
dead, including number two: "We shall not be a technology leader." To visualize
its demise, I created an imaginary article from a bogus June 1992 issue of
the aforementioned Forbes magazine, in
which I was quoted as reversing the cautious and provincial position I had
expressed seven years earlier. The new quote read: "We
are going to be the technology leader. We cannot afford not to be."
We began by bringing in Arthur D. Little to develop a major analysis
of our technology operations, the beginning of a year-by-year series of quantum
leaps that took our technology from 1990s followership to year 2000 leadership.
Today, it is impossible to overstate the importance of technology in our operations.
Our technology expenditures represent some 40% of our total operating costs.
By way of contrast, we spend barely 3% of the technology budget on the investment
supervision of the $370 billion of mutual fund assets we manage directly$150
billion in fixed-income securities and $220 billion in equities that track
various stock market measures such as the Standard
& Poor's® 500 Index.
Technology: Finances and Focus
While our expenditures on technology can be characterized as real moneyor even real, grown-up
moneyour operating expenses have actually declined in relationship
to our burgeoning fund assets. When I gave that stodgy quote to Forbes in 1985, our direct expenses of some $45 million
represented 0.41% (41 basis points) of our $10 billion-plus asset baseessentially
the figure that represents how much of a shareholder's investment return is
consumed by our direct costs. By 1999, however, that direct expense rate had
been slashed nearly 50% on our $500 billion base. We can't accept all of the
kudos for that reduction, however. For our total direct expenses leaped from
$45 million in 1985 to well over $1 billion last year. However, soaring stock
prices and huge cash inflows from investors carried our assets upward at an
even faster rate. Economies of scale in fund management were also a big help.
But modern communications and computer technology played a powerful supporting
role, and our now 2,000-person technology crew managed both the growth in
our shareholder base and the increasing complexity of our businesses processes
with extraordinary efficiency, economy, focus, and vision.
I might add here a word about management's role in all of this. Despite
what I view as the mind-boggling complexity of computers and investment technology,
of programs and processes, of bits and bytes, and of Bluetooth and XML, Bob
DiStefano reminds me that how we do technology
is far less challenging than deciding what
we doour objectives, our strategies, the allocation of our resources.
Be that as it may, the record is clear that we've been pretty good in both
areas. But we realize that we must never ignore the importance of setting
intelligent priorities for our technology resources, and the need to have
clear business objectives for each project we undertake.
I'll spare you my own pride in what Vanguard's Information Technology
team has accomplished. However, I won't spare you the results of the study
conducted by Information Week a few months
ago, in which we were ranked #40 among the 500 leading IT innovators. Indeed,
in the Banking and Financial Services category, we were ranked #7 among the
43 top firms, only two of our mutual fund peers even made
that list, ranking #13 and #25. What is more, we earned gold medals in each of four designated categories: Application Development,
E-Business, Customer Management, and Business Processes/ERP. So, eight years
after that imaginary Forbes quote that
I used in 1992 to illustrate the abrupt change required in our technology
prioritiesfrom complacent also-ran to clear leaderwe can fairly
be said to have reached our ambitious goal. This seems only poetic justice,
for the ship's motto of HMS Vanguarda name that has persisted in the
British navy for more than two centuriesis "leading the way."
The Miracles of Technology
Let me now turn from the miracles of what Vanguard's IT group has accomplished
to the miracles that technology has brought to the mutual fund industry. These
four stand out:
But, with all of this extraordinary technology available to investors,
I ask you tonight: To what avail?
- The emergence of a financial system that has enabled the professional
money managers of funds to offer a whole new variety of investment products,
to provide remarkable liquidity for transactions, and to transact business
around the globe at the speed of light.
- The provision of an up-to-date information network that provides
data about mutual fund portfolios and performance so vast as to be beyond
the ability of the human mind to absorb.
- The development of websites that not only provide fund shareholders
with real-time account valuations, but also financial-planning advice, including
recommendations on saving for retirement and on the allocation of investment
- The availability of a communications network so efficient
that investors can purchase and redeem fund shares instantaneously (albeit
so far with the transactions executed no more frequently than hourly), without
ever moving from their desktop computers.
Yes, computer technology has played a major role in the growth of the
mutual fund industry, adding a whole new order of magnitude to the growth
fostered by the 18-year bull market in stocks. Today, we have a new mutual
fund industry, one that is distinctly different from its staid, largely conservative
ancestorin variety, in concept, in investor participation, in service
quality, and in pricing. But the question is: Do we better serve investors?
A New Industry Emerges
Surely there are more fund choices. The number of mutual funds has exploded,
providing investors with an enormous variety of fund objectives, strategies,
and managers. Just 20 years ago, the old industry was composed of fewer than
300 equity fundsthe embattled survivors of the great 19731974
bear market, licking their wounds. The new industry comprises a bewildering
total of some 7,300 fundsnot only 4,000 equity funds, but 2,200 bond
funds and 1,100 money market funds as well.
However, to a surprisingly large extent, equity funds have become virtual stocksevaluated as individual common
stocks, purchased as stocks, traded as stocks, and discussed as stocks in
the corridors of commerce and at cocktail parties alike. For millions of investors,
funds are stocks, and when particular funds
are hot, that's where the investors' capital flows
and, of course,
What is more, yesterday's investment
industry has become today's marketing industry.
Once we sold what we made; today we make what will sell. Hot performance.
Mutual funds using sophisticated investment techniques are aggressive beyond
anything we might have imagined 15 years ago. Internet funds; micro-cap funds;
and quantitatively managed funds. Funds based on theories of price momentum,
earnings expectations, technical readings of the market, and multiple regressions
that, dare I say, boggle the mind. Even funds for stocks in Vietnam and Indonesia
and the Czech Republicnone hitherto known as bastions of capitalism.
Further, even old-line funds follow strategies that only yesterday would
have been deemed outrageous. On average, mutual fund managers turned over
their portfolios at a 15-percent rate in the 1950s and 1960s. Even in the
"Go-Go Years" of 19651968, the rate rose to "only" 40 percent. But
last year, the turnover rate was 90 percent, suggesting that the average holding
period for a given stock is now just 406 days. Such speculation not only flies
in the face of intelligent investment policy, it carries heavy transaction
costs and unnecessary tax costs that frustrate the objective of fund shareholders
to earn returns that even approach the returns earned in the stock market.
Whatever happened to long-term investing by professional managers? By anyone?
In short, mutual fund managersonce considered as long-term investorshave
become, to an important degree, short-term speculators. Many of the former
shepherds of the flock have become the sheep of the pasture: a roaming, inconsistent,
wild lot, given to impulsiveif sometimes precisely quantifieddecisions
that frustrate the very purpose of investing on the basis of traditional standards
of corporate valuation. We have investment technology to thank for its role
in helping us to engage in all of this feverish activity. But technology has
given us the tools without giving us the wisdom to handle them constructively.
A Flood of Information
The computer and the Internet have also given us nonstop access to data
that allow us to analyze and evaluate mutual funds beyond our wildest dreams,
and to make fund selections with unimaginably vast information literally at
our fingertips. Never again will mutual fund investors lack the ability to
make fully informed investment decisions. From that standpoint, mutual fund
investors are among the greatest beneficiaries of the computer revolution.
But they are also among its greatest victims. With each passing day,
mutual fund investors are provingas we must have known all alongthat
in investing, information is all too often mistaken for knowledge; and knowledge
is all too seldom translated into wisdom. But, wisdomfar more than
mountains of detailed dataand common sensefar more than opportunismare
ever destined to be the prime ingredients of long-term investment success.
Communications technology has given us immediate access to abundant
information when we are considering our fund decisionsto buy, to hold,
to add or subtract, to withdraw entirely. How much information? Consider Morningstar's
Principia database, in which it provides for each of the 3,000 stock funds
in its database:
It is no exaggeration to say that the superb Morningstar service provides
all the information an investor could possibly need to evaluate a fund's characteristics,
to understand a fund's character, and to make informed decisions. I fear,
however, that they rarely use this information to enhance their knowledge.
Rather, they rely on a fund's past performance and star rating. Our trust
is placed "in our stars, not in ourselves," precisely the opposite of what
Cassius told Brutus. But the "stars" do not
give investors the power to select future winners. While Morningstar's information
is priceless in understanding a fund's investment
style, past returns, and present portfolio, the evidence strongly suggests
that it is virtually worthless in enabling
investors to enhance their returns. Technology has made information accessible
without providing knowledge and without engendering wisdom. Perhaps a rereading
of the Book of Proverbs would remind us of what is really important: "Get
wisdom, get insight."
- For the stock portfolio: price-earnings ratios, growth rates,
market capitalization, industry diversification, rate of turnover.
- Risk characteristics: R-squares, Betas, Alphas, standard deviations,
- Past performance: annual and cumulative returns; monthly and
rolling three- months' rankings versus a market index, and versus peer groups;
- Investment styles: A matrix of nine boxes sorting fund both
by growth or value characteristics and by size of market capitalization, i.e.,
large-cap growth funds. (And funds must maintain their "style purity," no
matter what.) Portfolio manager experience, education, and tenure.
- Costs: sales charges, 12b-1 fees, expense ratios. (By the
way, please never ignore costs!)
- And the summum bonum: the
"Star" rating, based on risk-adjusted returns relative to other equity funds.
The Quality of Advice
With all the information and commentary that is available on Internet
websites, I find myself particularly troubled by the offering of investment-
and financial-planning advice. This advice is voluminous and comprehensive,
giving investors the ability to plan their financial futures with decimal
point precision and to manipulate the data to their hearts' content, raising
and lowering their expected retirement plan contributions; their allocations
to stocks and bonds; their assumptions about future returns in the financial
markets, about tax rates and inflation rates, and about retirement age. But,
at bottom, the data that is provided tacitly ignores the most fundamental
characteristic of investing: uncertainty.
I go quickly to the first principle: The stock
market is not an actuarial table.
Yet the projections provided in the numerous websites that investors can access
seem to me to cast an aura of predictabilityif not certainty, surely
high relative assurancein the numbers that appear. But the output,
as ever, is highly sensitive to the input. A few examples from three different
websites make the point.
In all, I believe much of our industry's information technology is presenting
investors with hypothetical information clothed in the mantle of precision.
Long-term investors, I think, would be far better served to simply stop trying
to outguess the unguessable, and opt for using a simple asset allocation plan,
not a complex one: owning the entire stock market, not trying to select winning
stock funds based on their past returns. Sometimes it is better to be roughly
right than precisely wrong.
- Consider a retirement plan for a 30-year old investor, investing
6% of his $50,000 salary in a 401(k) plan (with a 3% company match), his income
growing at 5% per year until planned retirement at age 65. If he believes
the stock market's annual return will be 12%, in 2060 (when he will reach
his actuarial life expectancy of 90 years) the accumulated capital would be
$22,848,149. (Note the precision!) If, on the other hand, the market return
turns out to be 9%, he runs out of money at age 81a zero balance, and
nine years too soon at that. But believe me, no one in the world knows which
of those two outcomes$22 million versus pauperhoodis more likely,
or can even imagine what the future return on stocks will be.
- Consider an asset allocation plan that calls for an "ideal
mix" for a risk-averse investor of 27% in bonds, 13% in foreign stocks, and
60% in large-cap growth stocksassuming future returns of 8.6%, 9.5%,
and 13.6%, respectively. (Again, note the precision.) Now bump the foreign
return up to just 10.6% and reduce the other two returns by a single percentage
point andabracadabra!the required foreign stock allocation rises
from 13% to 45% of the portfolio, bonds drop to 10%, and growth stocks drop
to 45%. Who, really, is fooling whom here?
- Consider another financial-planning websiteand an extremely
successful one at thatwhich does a fine job of presenting options that
show the probabilities of reaching your planning goal by the use of various
assumptions grounded in the dispersion of past returns in the financial markets.
This approach makes sense, but the system errs by making what appear to be
highly arbitrary projections of future performance for individual funds. It
assumes, for example, that three particular funds will produce a range of
nominal returns as follows: growth fund: 16.56% to 1.50%; value fund: 14.38%
to 2.02%; and the total U.S. stock market: 15.35% to 2.34%. (Precision again.)
Reasonable as these ranges seem to methough they are in no way assuredI
just can't imagine deciding to go with that particular growth fund simply
by reason of its putative superior future return under these tenuous assumptions.
Transaction Technology: Switch When the Iron Is Hot
Finally, transaction technology has given us the ability to trade both
stocks and mutual funds beyond our wildest imagination, as unambiguously unhelpful
as it is to fund investors and to the portfolio managers of the funds whose
shares they trade. Yes, technology has driven transaction costs down. But
it has also helped drive stock trading to its highest level since 1929, a
turnover of 100%, meaning that the average stock is now held for just one
year, compared to six years in the mid-1970s. The net result as described
in a compelling law review article:
even as computer and network technology dramatically reduces
the cost of and increases our access to information, our biological limits
ensure that individual and institutional investors alike consider only a limited
subset of all the data available
Purely speculative trading that
springs from the natural dispersion of investors' subjective opinions under
conditions of uncertainty, however, drains investor wealth. And the new information
technology may encourage speculation. In other words, securities markets may
be subject to the law of unintended consequences just as the rest of life
Unfortunately, if the demand for stock speculation is relatively
elastic, reducing the marginal costs associated with speculative trading can
have the perverse effect of increasing total costs (and with it, deadweight
losses). (Source: "Technology, Transactions Costs, and Investor Welfare,"
Professor Lynn A. Stout, Washington University Law
Review, 1997.)At least a few others share my concerns about the role technology has
played in creating this new world of hyperactive investing, and about the
accelerating pace of investors' turnover of fund shares. A recent New Yorker article described it in harsh terms:
giddy money managers [including, I would add, investors who
actively manage their own fund portfolios] are enthralled by the new gadgetrytechnology
now sits at the center of a speculative frenzy of religious intensity, a financial
mania, a bubble. In the mutual fund arena, turnover of equity fund shares by investors
has also soared. In the 1960s and 1970s, liquidations of equity fund shares
averaged 9 percent of assets per year; in the late 1990s, the rate has been
running at about 36 percent. Put another way, the holding period of the average
fund shareholder has tumbled from eleven years in the earlier era to slightly
more than three years currently. Just three years. Mutual fund shareholders are using the best medium
ever designed for long-term investing for the purpose of short-term speculation.
And they will be the losers.
Nonetheless, I freely concede that technology has served fund shareholders
extremely well in one sense: The unit costs of fund share transactions and
fund portfolio transactions have sharply declined. Indeed, their decline has
already helped to reduce the costs of operating mutual funds. Computer costs
have plummeted by almost 99 percent, from $150,000 per million instructions
per second (MIPS) in 1985 to perhaps $1,000 per MIPS today. The cost of a
personal telephone response was $10 in 1985; today, it is only $2 for an automated
telephone response (a bit discomforting for many investors). When a printed
fund prospectus is delivered, the cost is $8; when the same prospectus is
delivered over the Internet, the cost is essentially zero. Fund transactions
can be electronically implemented and processed by pushing just a few keys
on a personal computera further huge savings.
It was recently estimated that some 30 million of 50 million fund investors
have home computers, with 10 million using them in investing. (Another estimate
suggests that 30 percent of fund shareholders in the largest mutual fund casinomy
word for the mutual fund supermarkets where trading fund shares is at least
tacitly encouragedalready handle their transactions in its website.)
Today's 10 million users will soon become 15 million and then 20 million,
and they will all have the ability to redeem their shares at a moment's notice.
It takes only a moment's contemplation to imagine what might happen in the
financial markets if, say, half of that number responded to a major earthshaking
(literally or figuratively) news event. The industry's old gatekeepera
busy signal on the telephoneis retiring, for better or worse. Perhaps
busy Internet service provider numbers, or even an Internet crash, will "protect"
us if the dark day comes, but perhaps not. Honestly, it's sort of scary.
The Report Card
Let's grade each aspect of the technologies currently used in mutual
My report card would rate the contribution of technology to information
as A+; to knowledge, C; and to wisdom, D or perhaps even F. In all, good grades
go to the technology, bad grades to the users.
- Investment technology: Innovative
financial instruments, A+; liquidity, A+; cornucopia of funds, A+; soundness
of new funds, C; investment behavior of mangers, D.
- Information technology: Availability
of data to investors, A+; completeness and scope, A+; availability of meaningful
knowledge, A; effective use of that knowledge, D; intelligent selection of
funds for future performance, D; investment behavior of shareholders, F.
- Transaction technology: Ease
and facility, A+; implicit encouragement to trade funds, A+; efficiency and
expense savings, A+; flow-through of lowered costs to fund shareholders, F;
facilitation of enhanced shareholder returns, F.
What does the technology revolution portend for tomorrow? More websites,
more bulletin boards. More information, more transactions, still more facilitation
and speed, and more cost savings (though probably not flowed through to the
benefit of fund shareholders). And, I must add, more risk. Most of the new
financial instruments made possible by the computer power of technology have
never been tested in the crucible of a bear market. Nor have most fund shareholders,
who are now able to trade without restraint. And, given the Internet, they
can do so without even the intercession that used to be representedfor
better or worseby the inability of funds to staff enough telephone
lines. Anyone who is not cognizant of these risks is, in my view, making a
But I am not an aging Luddite who is renouncing the future and calling
for a return to the past. We can't go home again. But I do hope we will soon
return to the fundamental principle that mutual funds are best used as long-term
investments. I'm enough of an idealist to be confident that the kind of casino
capitalism that is in the air today will not be a permanent fixture in the
mutual fund industry. For trading in fund shares not only places roadblocks
in the way of the implementation of sound strategy, but also engenders additional
costs to all of the shareholders in the fund. What is more, it is also a loser's
game for fund shareholders who elect to follow active trading strategies.
Technology, for all its gee-whiz wonder, is both a bane and a blessing.
In the fund industry, the idea of something for nothing is rife, and
plain fantasy about future returns abounds. My asking earlier, "To what avail?"
regarding the remarkable advances in the application of technology, was not
intended to demean them. I only urge that this industry give far more thoughtful
consideration to curbing the powerful monster we have created and to figure
out how to make it bow to our will, not us to its will. We must begin by obliterating the
notion that funds should be treated as individual stocksactively traded,
sometimes in exotic forms, by managers who can create miracles. Abandoning
the massive advertising of funds as though they were beer or toothpaste or
perfume would be a step in the right direction. And we ought to give serious
consideration to appropriate limitations on frequency of exchanges, and fee
penalties for investors who redeem shares after short holding periods. All
of these steps would be met with horror, not only by short-term investors
who are using funds as stocks, but by the fund managers who seek additional
assets without concern for their durability. But each of these steps would
serve the interest of the long-term investors whom we are sworn to serve.
I concluded my draft of these remarks before President Clinton used
some familiar words from Benjamin Franklin to close his recent State of the
Union Address. But, perhaps shamelessly, I'm going to present them to you
anyway, for I want to end my remarks on an upbeat note. At the close of the
Constitutional Convention in 1787, speaking of the new republic that had just
been created, Franklin pointed to General Washington's chair, on which a sun
was painted in gold leaf, and observed:
I have in the course of the Session, and the vicissitude of my hopes
and fears, looked at that sun without being able to tell whether it was rising
or setting. But now I have the happiness to know that it is a rising and not
a setting sun.
Similarly, I would express my own hopes and fears about the impact of
computer technology on the new mutual fund industry we have created. Whether
it is a rising sun or a setting sun is, finally, up to mutual fund investors.
But it is up to fund executives and our information technology leaders, to
keep in mind not only information, speed, cost, and efficiency, but common
sense, foresight, and wisdom.
Note: The opinions expressed in this article do not necessarily represent the views of Vanguard's present management.
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