Remarks by John C. Bogle, Founder and Former Chairman, The Vanguard Group
Before the Town Hall of Cleveland
October 12, 2000
It’s hard for me to believe that I’ve now been in the financial field for one-half a century. For it was in 1950 that I began to write my senior thesis on the mutual fund industry, and I have been part of it ever since. The title of my brand new book, John Bogle on Investing: The First 50 Years, includes the publication of that ancient thesis, as well as my thoughts about the financial markets, the fund business, and Vanguard. I’m delighted to have this opportunity to discuss with you the changes that have taken place during that half-century. "May you live in interesting times," may be an ancient Chinese curse, but it has been a blessing beyond compare for me to be, not merely an eye-witness to history during this, well, interesting era for investing, but an active participant in it.
What a difference half a century makes! In 1950, stocks and bonds were barely in the public consciousness; now they seem rarely out of it. Then, past market returns had been dull and plodding; since then they have been the highest in all U.S. history. Then, the dividend yield on stocks was three times the bond yield; now the bond yield is nearly seven times the yield on stocks. Then, the market was dominated by individuals; now it is dominated by financial institutions. Then, a ticker tape machine actually printed stock price changes every step along the way; now electronic networks display real-time prices on our computers. Then, trading was peaceable and orderly; now, trading is competitive and hyperactive. The world of investing in 2000 little resembles its 1950 counterpart.
With today’s pervasive public interest in investing, reflected in the deluge of financial information that races down on us by the hour, it’s hard to imagine how far removed from our concern the financial markets used to be. In 1950, perhaps one million families—one in 45—owned common stocks. Business pages were rare, except in the metropolitan papers (and even sparse there). Fortune, Forbes, and Business Week had few rivals in the financial magazine marketplace. And if there were a single television (or even radio) program about investing, I don’t recall it.
The Rise of People’s Capitalism
Again, what a difference a half-century makes! Today, some 60 million families—six of every ten—own common stocks. A half-dozen cable television channels are importantly, even slavishly, devoted to investment news. Even the national networks regularly present business and financial stories along with daily—even hourly—updates on the stock market. Money, Smart Money, Your Money, Young Money, Family Money, and a score of other magazines about money—some with readerships in the millions—compete vigorously with those three familiar business magazines of the 1950s.
America has truly become the world’s first bastion of "people’s capitalism." Karl Marx’ 1848 prophecy that the proletariat would own the means of production has at last come true! Much of this growth in share ownership has come from the formerly embryonic mutual fund industry, a growth fostered by, of all things, our government. Mutual funds have been the primary beneficiary of tax-favored savings plans—IRAs, 401(k) corporate thrift plans, 403(b) retirement plans of non-profit organizations—that would not have been possible without Federal legislative and regulatory action. These programs provide investors with the incredible advantage of long-term compounding on a tax-deferred basis, a concept so pervasive today that it is hard to imagine that fifty years ago it was barely in the public consciousness.
As the 21st century begins, it’s fair, if ungrammatical, to say that stocks and bonds are "where it’s at." Small wonder, given their sheer dollars-and-cents importance on the balance sheets of American families. Back in 1950, U.S. citizens held $500 billion of financial assets, of which $154 billion—less than one-third—represented equity holdings. Today, we collectively hold $32 trillion of assets, with $15 trillion—nearly one-half—represented by equities. With so much of our future now dependent on the stock market, hovering over the daily peregrinations of the Dow Jones Industrial Average, the Standard & Poor’s 500, and the NASDAQ have become—for better or for worse—our way of taking the temperature of our financial well-being.
Much of this massive increase in stock ownership, of course, simply reflects the increase in the value of the financial assets on our collective balance sheet engendered by soaring stock prices. But the Great Bull Market has also whetted our appetite to acquire more stocks. When stocks go up, we want to own even more. The rise in market values has been astounding. The Dow, for example, priced at 235 when 1950 began, currently reposes, a bit shakily, just above 10,000. And that 45-fold gain is but a pale shadow of the near 70-fold gain in the Standard & Poor’s 500 (then 90) Stock Index. The S&P, in those olden days an obscure index largely known only to statisticians, has risen from 20.41 to 1360. But these figures ignore the dividends paid on the stocks in the index. When dividends are taken into account, the 1950 investor would have more than a 500-fold gain. An investment of $1,000 in the S&P Index at the start of 1950 would now be worth $515,000—more than a half-million dollars, the result of a 13.3% compound rate of return. Remarkable!
A Frenzy of Activity
In the increasingly superheated investment environment of the Great Bull Market, stock trading, perhaps not surprisingly, has gone through the roof. Fifty years ago, two million shares changed hands each day on the New York Stock Exchange. Today, two million shares change hands every minute. Day after day, one billion shares trade on the Big Board, and another 1.5 billion shares trade on the NASDAQ, today’s version of the tiny "over-the-counter" market of 1950. The annual rate of turnover of stocks has risen from 18% to 150%, meaning that the average share, then held for more than five years, is now held for something like eight months. "Speculative frenzy" is not too strong a phrase for today’s feverish activity in stocks.
We can credit (or blame) much of this activity on the Technology Revolution, which has given us lightning-quick communication of unlimited information. Add in the media’s breathless reporting of market news; the hype surrounding technology stocks (especially Internet stocks); electronic trading networks, often used by "day-traders" seated at home by their computers; tumbling unit transaction costs; and the plethora of financial data available at the finger tips of impatient portfolio managers; and we have reached a level of stock market turnover not seen since 1929.
Institutionalization and Mutual Funds
This activity comes despite one of the most significant trends of the era: The institutionalization of the stock market. In 1950, private pension funds and mutual funds together held some $3 billion in equities—less than 2% of all stocks outstanding. Today, equities held by these two sets of institutional investors have grown to a total of $8 trillion. Adding in nearly $1 trillion of equities held in bank personal trust departments, more than one-half of all equities are now held under professional supervision and trusteeship. Alas, fiduciary duty has failed to deter our financial institutions from joining with the general public in today’s stock trading frenzy. There has been but a single major institutional exception to the wild trading of stocks: The index fund—essentially a portfolio that owns every company in the entire stock market and holds it forever. First created in 1975, index funds have gained remarkable acceptance, and now own fully one-tenth of all U.S. stocks.
The mutual fund industry is a perfect example of what’s happened in the investment field during the half-century. In 1949, after fortuitously reading an article on the industry in Fortune magazine, I chose this industry as the subject of my Princeton University senior thesis. In it, I endorsed Fortune’s description of the then-$2½ billion fund industry as "tiny but contentious." Now responsible for $7 trillion-plus of assets, it is tiny no longer. Then, The New York Times listed the prices of but 109 funds, covering just eight column-inches. Today, there are 8,000 funds, and each day’s mutual fund price listings in the Times require 648 column-inches, or, if you will, 54 column-feet, covering two and one-half full pages.
But contentious this industry remains. Despite the awesome responsibilities it owes to its shareholders, over the years it has become primarily a business of marketing rather than management, with funds coming and going at a high rate, with a short-term investment focus, and with significant inefficiencies and excessive costs borne by fund shareholders. The industry has pretty much ignored the clear policy recommendations I expressed in my thesis: Put the interests of fund shareholders first; focus on management above all else; don’t claim the ability to beat the market; and cut sales charges and management fees. Nonetheless, the industry has realized, many times over, the "tremendous growth potential" I visualized for mutual funds all those years ago.
The Financial Markets Today
With that brief chronology of the past half-century, let’s take a look at where we are today. First, the dynamics of the financial markets have changed radically. While in hindsight it now appears obvious that stocks were a screaming buy in 1950, our parents, who had suffered through the Great Depression, were not only worried about a recurrence but lacked the wherewithal to invest. Indeed, after the build-up of our national economy during World War II, many pundits were still expecting a serious recession—or worse. Today, on the other hand, fear is conspicuous only by its absence, and stock market participants seem to feel that trees can indeed grow to the sky.
In that earlier atmosphere of caution, the 8.7% dividend yield on stocks was at its historic peak. By contrast, in today’s ebullient atmosphere, the stock yield is at its historic low—a skinny 1.1%—an 85% drop in yield that has resulted from the 70-fold rise in stock prices in the face of a mere eleven-fold increase in dividends. Then, bonds, the traditional alternative to stocks, yielded 2.6%—one-third of the stock yield. Now bonds yield 7.2%, fully six and one-half times the stock yield—an extraordinary, indeed unprecedented, reversal of fortune.
As investors look ahead from this perspective on the past, the most important thing we must realize is that it will be difficult for stocks to "do it all over again." It is not merely that the past is not prologue, but that today’s circumstances virtually preclude the past being prologue. To understand why, we need only understand the simple mathematics that drive stock market returns.
The total return on stocks is the simple product of their investment return plus their speculative return. Investment return consists of the dividend yield on stocks plus the annual rate of earnings growth. Speculative return is the impact on stock prices of a change in the price investors are willing to pay for each $1.00 of earnings (the "price-earnings ratio"). For example, if investors decided overnight that stocks were worth not 15 times earnings but 20 times earnings, stock prices would immediately rise by 33%. If that rise were spread over a decade, it would add slightly less than 3% a year to the investment return.
So if the investment return were 8% (say, a 3% stock yield combined with 5% annual earnings growth), a rise in the P/E ratio from 15 to 20 would add a speculative return of 3%, bringing the total return on stocks 11% for the decade. On the other hand, if the ratio fell to 10 times earnings, the speculative return would be minus 4%, reducing the 8% annual investment return to 4%. Each of these components—dividends, earnings, and the P/E ratio—makes a profound difference in what returns stocks provide to investors, a difference dramatically enhanced by the impact of compounding.
Stock Returns in the Future
How dramatic? Wow! Consider the past half-century. The 13% annual return that stocks provided—the highest in U.S. history—reflected a dividend yield of some 4% and annual earnings growth of 6%, for a total investment return of 10%. The extra 3% per year reflected a speculative return borne of an increase in the P/E ratio from 7 times to 30 times, spread over the period. The value added by that soaring multiple was hardly inconsequential. Indeed, absent the 3% speculative return, that $515,000 of wealth created by the 13%-plus compound market return would have been just $135,000. Put another way, that reversal of fortune in speculation, from fear to hope—or even greed—was responsible for $380,000 of the $515,000 gain.
Given the mathematics of the marketplace, it will be extremely difficult for the past to be prologue. Consider each of the elements of return: Today’s dividend yield is just over 1%, a fraction of the average yield of 4% since 1950. For the investment return to reach 10%, then, the rate of annual earnings growth would have to increase from 6% to 9%—a 50% increase—one that, while not inconceivable, is far from assured. Yes, I know we’re living in a New Era of technology, communications, and science. But corporations remain subject to competition, regulation, and change—now more than ever, radical change in the way we Americans live—to say nothing of the serious challenges posed by globalization. The world remains an uncertain place.
What is more, to add another three percentage points of speculative return to reach the 13% annual total return of the past would require a rise of another 33%—from 30 to 40—in today’s P/E ratio over the next decade (I’m not sure that looking out to the year 2050 would be all that helpful.) Possible? Certainly. In the stock market, anything can happen. Likely? I don’t think so. Consider that prior to 1995, P/E’s had never exceeded 24 times. And whenever they approached 24 times—at the market’s highs in 1929, 1973 and 1987—a major bear market shortly followed.
So it seems a bit of a stretch to look for further increases from today’s P/E level of 30 times. And were the ratio to recede to 20 times—a traditional sign that stocks were high—the negative four percentage points of speculative return engendered by such a retreat would reduce my earlier rather optimistic projection of an investment return of 10% over the next ten years to a market return of just 6%, well below the yield available on investment-grade bonds today. Yes, I know that the odds are against it. After all, bonds have produced higher decade-long returns than stocks in only six of the past 60 10-year periods, and in but one of the past 100 25-year periods. Nonetheless, the stock market is not an actuarial table, and never will be one.
Alas, The Financial Markets Are Not For Sale
Whether future returns on stocks will fall short of the bountiful returns of the past half-century or whether they will equal or even exceed them, please bear this critically important fact in mind: The financial markets are not for sale, except at a high price. The stock market returns I have presented to you reflect the returns on the Standard & Poor’s 500 Stock Index, absent investment costs and taxes. They thus reflect the entirely theoretical possibility of cost-free, tax-free investing. But when we consider the inevitable costs of investing, reality bites theory. As must be obvious, all investors as a group earn the market return, and beating the market is a zero-sum game. Thus, the conclusion is self-evident and inescapable: The net return of all investors as a group must fall short of the gross return of the market by the amount of their costs. Then, beating the market becomes a loser’s game.
The impact of cost is not large. It is enormous! Remember that 13.3% additional return generated by the Standard & Poor’s 500 Stock Index since 1950? Well, if we assume that a mutual fund earns the same 13.3% on its portfolio (and in fact the average fund seems to earn just about what the market earns), but carried total costs very conservatively estimated at 1.8% per year*, the return would have been reduced to 11.5%. And if we assume, again very conservatively, that federal and state taxes on the typical tax-inefficient fund would have consumed at least another 2.8% per year, the fund’s after-cost, after-tax rate of return would have been reduced by 4.6% per year to just 8.7%, less than two-thirds of the market’s annual rate.
But of course these are annual returns. Compounded over the years, costs take a far greater toll. Of course, it is the magic of compounding high returns that got us to that $515,000 total I mentioned earlier. But it is the tyranny of compounding high costs that then slashes that return. After investment costs only, that figure shrinks by nearly 60%, to $230,000. And after estimated taxes, that total in turn is reduced to—I’m glad you are sitting down!—to just $65,000, leaving the investor with, not 40% of the market’s return, but just 13%. Astonishing! The investor puts up 100% of the capital, assumes 100% of the risk, and—after the croupiers represented by our financial intermediaries and our tax collectors have raked away their 87% share—receives just 13% of the return. It just doesn’t seem like a fair share . . . or a fair shake.
Given that mutual funds have been plagued by high management costs, high turnover costs, high opportunity costs, and profligate tax-inefficiencies, how is it that the fund industry could become the darling of the financial services field? Why have investors been willing to seemingly ignore the slings and arrows of outrageous costs and taxes? The answers, it seems to me, are obvious.
- The fund industry has come of age in an era of exuberant markets. Yes, with the 17% annual market return of the past 15 years, the average fund has produced a pre-tax return of only 15%. But 15% "ain’t bad." Few fund investors seem to pay much attention to relative performance.
- Some 40% of mutual fund assets are held in tax-deferred savings plans, and returns are not affected by taxes in these plans until investors retire. The remaining 60% of assets are held in taxable accounts, and investors pay their taxes, not out of their mutual fund account, but out of their checking account. Thus, they simply aren’t aware that their average after-tax rate of return is but 12%.
- Fund investors rarely assess with precision the actual returns they earn, likely remembering the funds that have done well for them and liquidating those that have not. When they move their money to other funds, it is usually on the basis of their past performance, unmindful that the predictive power of past performance is virtually nil.
- Most important of all, precious few fund investors focus their attention on the long term, and are thus unaware of the baneful toll that the compounding of costs takes on the accumulation of wealth. Imagine that young investors became aware that a 50-year investment horizon is actually relatively short. (If you begin investing at age 25 and retire at age 65 with a 20-year life expectancy, that’s 60 years.) Then imagine that they were informed of the 87% reduction in wealth I’ve just shown you. Surely fund shareholders would then realize, not only that cost matters, but how much cost matters over the long-run.
Of course there cannot possibly be an experienced fund executive who is not fully aware of these serious performance shortfalls of which their investors seem so blissfully unaware. Yet I observe that precious few fund organizations are willing to deal with these issues. Fund fees and expenses keep rising, short-term investment strategies have become almost omnipresent, taxes remain virtually ignored by fund managers and largely undisclosed by fund marketers, and the focus on charismatic marketing rather than disciplined management is intensifying. What is more, in recent years many no-load organizations traditionally have sought to build distribution by adding sales charges to their funds. I wish that I could point to a dozen firms that stand as exceptions to these trends, but the fact is that Vanguard, the firm I founded 26 years ago last month, is one of a precious few, in fact as well as in reputation.
Vanguard was designed as an experiment in mutual fund governance—in structure and philosophy—in which the interests of the clients would be paramount. From the outset, I have frankly described our firm as "the Vanguard Experiment," since the fund shareholders themselves, not the external organization that traditionally has represented the way the fund firm is organized, who are in the driver’s seat. Back in 1974, there was no way of knowing whether a truly mutual mutual fund firm—a firm that would operate at cost, would place stewardship before the personal gain of the managers, would be operated in a Spartan fashion, would eschew marketing, would enter into advisory contracts only with firms that would negotiate fees at arm’s length, would espouse simple strategies like owning the entire stock market (or, for that matter, the entire bond market), and would dedicate itself to giving its shareholders a fair shake—whether such a firm could succeed in its unique and hitherto untried mission.
Without my citing endless batches of boring numbers cataloging our assets, our growth, our market share, our fund investment returns, our innovation, and, Heaven knows, our famously low costs, I think you know enough about Vanguard to determine for yourselves the extent to which we’ve succeeded. But whatever we may have accomplished, our corporate character can be easily described: The magic of simplicity in an empire of frugality. We march to a different drummer: Of the shareholders, by the shareholders, and for the shareholders. Our unremitting ethic: Put the shareholder first.
A Question of Ethics
The ethical standard of the industry is different. I hope it is not unfair if I characterize it as "to make money for ourselves by making money for our shareholders." And as long as that is the accepted standard for the profession, I suppose it follows that all firms that follow the industry standard are, by the common definition, ethical. Indeed, our industry brags that it has never had a major scandal, a claim that is true in a literal sense. But such a claim can only be valid if one disregards the plain fact that, compounded over time, the returns earned by equity fund shareholders—after costs and taxes—have provided a scandalously small portion of the returns provided by the stock market itself. (The same must also be said of shareholders of bond funds and money market funds, relative to the bond and money markets.)
While I am a lonely voice in raising these concerns, I am not alone. In a recent publication of the Association of Investment Management and Research (AIMR, the professional organization for the investment management industry), Jason Zweig, the thoughtful and respected columnist for Money magazine, listed these four key ethical issues confronting mutual funds:
- "Tax inefficiency, reflected in attempting to maximize pre-tax returns for clients, even at the expense of after-tax returns.
- "Benchmarking returns, reflected in trying to beat a benchmark rather than trying to earn the best returns they can.
- "The fee explosion reflected in a 50% rise in (unit) expenses in the past four decades, with fees paid at the same rate whether the managers perform well or poorly.
- "Promoting fund performance when it is at a peak and ignoring the fact that it won’t remain there. Regression to the mean is the most basic law of financial physics."
Mr. Zweig is concerned, as I am concerned, that the business decisions that money managers are making for their fund clients are decisions that it is impossible to imagine they would make in their own personal investment programs. This great divide between advisors and clients is not what stewardship is all about. A money management firm, Zweig argues, "cannot be ethical unless it asks not only how something benefits the firm but also how it benefits its clients." Unless firms put the best interests of clients first, he warns, "the mutual fund industry will end up a quaint artifact, squandering its natural role as the greatest contribution to financial democracy ever devised."
Reprise: The Mathematics of the Markets
By putting its shareholder first and focusing on minimizing the costs of investing, Vanguard is simply recognizing the inherent, inevitable, unavoidable mathematics of the financial markets that I described to you earlier. Beating the market is a loser’s game. And a loser’s game by a wide margin, as you’ve seen, given the heavy burden of investment costs. What this wide gap between market returns and fund returns means is that the odds of an investor significantly outpacing the stock market itself over the long-term can be reasonably estimated at one in 50. With those odds against winning, and with the average fund earning perhaps 75% of the market’s annual pre-tax return (after taxes, it’s worse), it seems amazing on the face of it that so relatively few investors have yet awakened to the fact that as much as 99% of the market’s return is there for the taking, and virtually guaranteed to boot. How? Through a low cost all-market index fund—a fund that, in the ideal, owns every stock in the U.S. market and holds it, well, forever. (Or a bond market index fund doing essentially the same thing.)
We created the first stock-index mutual fund in 1975, and the first publicly-available bond index fund in 1986. We now manage some 25 funds tied to various indexes or asset allocation strategies, and are alone managing nearly two-thirds of all the indexed assets in the fund industry. It is not enough to say that these funds represent 45% of our $580 billion asset base. We also apply the principles that make indexing work—essentially, broad diversification, low turnover, low cost, and carefully-defined investment style—to most of the actively-managed stock funds and all of the fixed income funds that Vanguard offers. We have, in effect, "bet the ranch" on a single principle that flowed so easily and naturally from our structure, virtually from the very day we began 26 years ago.
By holding investment costs to the minimum, an index fund can capture almost 100% of the market’s pre-tax return. And while taxes are certain, such a fund, by eschewing the hyperactive trading that afflicts most mutual funds, is remarkably tax-efficient. And therein lies its winning formula. By assuming that an index fund modeled on the S&P 500 had in fact operated over the past 50 years, we can easily make the comparison. Such a fund, operated at an easily attainable cost of 0.2% a year and incurring estimated taxes of but 1.4% per year, would have provided a net return of 11.7%, just 1.6% less than the S&P’s annual return of 13.3%, and three full percentage points greater than the 8.7% return of the average fund (shown in my earlier illustration). Then those twin miracles of compound interest—the magic of return, the tyranny of cost—do their work. That initial $1,000 investment compounds, after cost, to $470,000 in the index fund, compared to $230,000 for the active fund. After costs and taxes the results are: Index fund, $250,000; active fund $65,000. Double the after-cost return. Four times the return after costs and taxes. "Betting the ranch" on low cost and index-oriented strategies turns out to have been a low-risk strategy for our embryonic enterprise.
Building a company that works for investors has been a thrill, and I continue to thrive in my career, now through Bogle Financial Markets Research Center. I’ve just written my third book on investing, and I hope that it, like its predecessors, will help make the world just a little bit better for investors. And of course I’m honored that McGraw-Hill selected it as the first volume of its series, "Great Ideas In Finance." As I re-read my Princeton thesis in preparation for its publication in the book, I found a surprising consistency in the ideas and ideals that I continue to express to this day. The thesis begins by stating that "the prime responsibility (of mutual funds) must always be to their shareholders," and ends with a demand that funds must serve—"serve both individual and institutional investors . . . serve them in the most efficient, honest, and economical way possible." In this case at least, I guess it’s fair to say that "the more things change, the more they remain the same."
Conclusion: Looking Ahead
In that vein, I’d like to conclude by returning to the idea of change and sameness, and speculate with you on what the past half-century may tell us about the next half-century. Despite the lingering suggestion in the title of my new book that I’m going to be around for the next 50 years, such a horizon might seem to be a bit of a push. Not so fast!
For as some of you may know, I’m the fortunate beneficiary of a medical miracle. Five years ago, almost to this day, close to death’s door with a rapidly failing heart, I entered Philadelphia’s Hahnemann Hospital. After a 128-day wait, supported by constant intravenous infusions, I became the recipient of a 26 year-old heart. So it is a mere child of thirty—"heart-wise," as they say—who stands before you today. Given the second chance at life I’ve been given by my heart transplant, all that heart has to do, by golly, is make it to its age 80 and carry this frail body along!
In the world of finance, it is certain that one thing that will remain the same is that investment success will be represented by the allocation of market returns between investors on the one hand and financial intermediaries on the other. That is why beating the market remains a loser’s game today, just as it has been over the past 50 years, and, for that matter, forever. The title of a popular book of 1940 pungently summarized the idea: Where are the Customers’ Yachts?
Yet while the market is the same old formidable foe, the returns we can expect from the stock market will change. And you’ve earlier heard my view that returns are apt, indeed almost destined, to be significantly lower in the coming era. While we are in a New Era in the economy, there is no New Era in the stock market. The eternal paradigm remains: Hope, greed, and fear may drive the speculative enthusiasm of the moment, but it is the fundamentals—earnings and dividends—that will drive the market’s era-long returns.
What else may change and what else may remain the same? Let’s speculate a bit, starting with what may change:
- Today’s overweening focus on the daily sound and fury of the stock market will abate, as investors recognize that prices move up and down, and that simply ignoring these fluctuations and eliminating (or trying to eliminate) emotion from the investment equation is the secret of optimizing investment returns.
- As investors recognize the futility of trading, today’s extraordinarily high transaction activity in stocks will recede, if not to 1950 levels, at least to annual turnover levels well short of this year’s 150%. Symbolically reaffirming this change, the NASDAQ bulletin board on Times Square—"the largest television screen in the world!"—will move to Wall Street, where it belongs.
- As investors realize the heavy toll taken by costs and taxes, they will at long last begin to abandon their short-term focus and do what they should have been doing all along: Invest for the long-term. Again symbolically, the Weather Channel will replace the business channel as the most popular day-long TV fare.
- Economic and financial education will increase sharply. But it will begin to focus on what matters. One symbol of progress, I predict, will be when high school classes abandon their titillating "stock-picking" contests and begin to teach the simple, boring mathematics of long-term compounding.
- As investors vote with their feet, the mutual fund industry will recognize it has no monopoly on the affections of investors. We will change, as we at last find our way, returning to the principles of stewardship and fiduciary duty, and fulfilling our natural role as "the greatest contributor to financial democracy ever devised."
What Will Remain The Same
With all this change, however, much will remain the same.
- Common stocks will remain the investment choice for America’s families. Despite the fact that the market is all too likely to suffer a few severe bumps during the next few years, most investors will learn to stay the course. Where else can investors turn other than the ownership of American business to find the extra returns required to assure the financial resources that will sustain their retirement?
- Common stocks will continue to provide a long-term risk premium over bonds. However, as both their risks and returns become even better understood, the historic 6% real (inflation-adjusted) premium accorded equities will ease downward, perhaps to as little as two to three percent.
- Indexing will—as it must—continue to prove itself year after year to all but the "I’m too smart for that" and the "Hope springs eternal" crowds. Statistics being statistics, of course, in some years indexing won’t look as if it wins, and we’ll be told by the vested interests that the era of the active manager has miraculously returned and "it’s a stock picker’s market again," ignoring the plain fact that the reality of the mathematics of the market is inescapable. No matter. The use of indexing strategies will increase steadily and significantly.
- Social Security will—and this may surprise you—remain intact. But only because long-overdue adjustments are at last made to increase revenues (some taxability of benefits) and to reduce distributions (a more realistic inflation adjustment; a retirement age that reflects our longer lives). However, an optional stock-investing plan, overseen by an independent Social Security Investment Board, will become available for a portion of an employee’s regular contributions. The vehicle? No surprises here: A low-cost all-market index fund.
And Finally, Some Important Imponderables
As what changes, changes, and what remains the same, remains, the increasing importance of equity investing in the balance sheets of our citizenry will raise important policy issues. While "People’s Capitalism" will remain the American ethos, I’m not at all sure what the social impact of ownership of stocks by our entire population of those millions who can afford to invest—and hence de facto corporate control by the public—will have on our political system. How, for example, can the citizenry be against "big business" when, by owning stocks, "we the people" are big business? In the fullness of time, we shall see.
At the same time, we’ll have to consider the implications of living in a more "market-dependent" economy. With one-half of the assets of our families invested in stocks, and with the financial markets ever subject to extreme waves of optimism and pessimism, will these swings be translated into greater volatility in the economy itself? Clearly, as risk is increasingly transferred from corporations and financial institutions to individuals, more enlightened and rational attitudes about the stock market will be required. Even today we see the Federal Reserve focusing on the level of stock prices as it tries to steer a stable course for the economy. But, in the long run, stocks cannot be propped-up at unsustainable levels by encouraging words or easy monetary policy. I hope that as common stocks inevitably enter the political arena, our governmental authorities will have the wisdom to let the markets take their own course as, finally, they must.
I’ve covered an exciting half-century of investing for you today, an era in which I’ve been blessed with the opportunity to be both an observer and an active participant. You can be sure that the future will be filled with surprises and challenges, elation and heartbreak, things that change and things that remain the same. And if the miracles of life that have carried me this far—if my body doesn’t change too much and if my heart remains the same—I’ll be back with you in 2050 to discuss how my predictions worked out!
*Today, the annual expense ratio of the average mutual fund is about 1.6%; portfolio transaction costs incurred by the heavy trading of mutual funds is at least 0.7%; the opportunity cost that funds incur by holding cash reserves rather than stocks would cost about 0.3% in a moderately good market, and the sales charges paid to acquire most funds, amortized over time, is at least 0.5% per year. Total cost: 3.1%, or well above my conservative 1.8% estimate.
Note: The opinions expressed in this article do not necessarily represent the views of Vanguard's present management.
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