Remarks by John C. Bogle
Founder and Former Chairman, The Vanguard Group
New York City, New York
November 15, 2001
In January, 2001, when I accepted your kind offer
to join you this evening, little did any of us imagine that the
first year of a new millennium that began with such great promise
would end with such staggering challenges to our American way of
life. Our economy has beenand will continue to begreatly
affected by the attack on America, and I'd like to talk to you tonight
about what's next in three different financial odysseys: The long
adventurous journeys of the stock market, the mutual fund industry,
What happened on September 11, just four miles from
here, struck like a stiletto into the American psyche and our economy.
Its echoes quickly reverberated across our financial markets, reminding
us once again of one of the most elemental realities of investing:
Stock market returns are created by just two factorseconomics
When the stock market reopened after the attack, emotions
held sway. How could it have been otherwise? The collapse of the
proud towers; human beings plunging 100 stories to their death,
often hand in hand; the poignancy of a husband's final words to
his wife on a cell phone; the threat of terrorism; American troops
hunting an elusive foe in deepest Asia; nervousness about our financial
system; fear of a change in our way of life. It was a dark moment
in U.S. history; indeed, it's difficult to imagine a more emotion-packed
time in American history than the days and weeks following the attack
on our nation that took place on September 11, 2001.
The Birthand Burstof a Bubble
When the attack came, a bear market was already underway.
At the peak of the technology bubble in March 2000, the total value
of all U.S. stocks was $16.2 trillion. As the market prepared to
open on September 11, that value had tumbled to $12.1 trillion,
a decline of 30% in the total stock market index. Most of that drop
was represented by the burst in the "new economy" bubble,
with the technology-driven NASDAQ Index off 66% and the largely
"old economy" New York Stock Exchange Index off but 16%
from the high.
Yet while a $4 trillion loss in market capitalization
is hardly insubstantial, veteran investors recognized that muchperhaps
allof that $16 trillion total never had much substance in
the first place. We usually know what is coming, but we never
know when. (That's why we're not market timers!) After all,
the market had also been valued at $12 trillion as recently as early
1999, and most investors were ecstatic with the returns they had
earned. The dip simply represented a return to reality, a change
in the market's emotional state from greed to what seemed like caution.
The powerful emotions unleashed in the aftermath
of the attack quickly soured the mood of investors. Fear was in
the saddle, driving the market down another 14% after the market
reopened, erasing another $1.4 trillion of value. Only a fool would
challenge the notion that some degree of fear wasand still
iswarranted. Our world has changed. But wise investors realize
that, time and again through stock market history, the emotions
reflected in the market pendulum have swung from optimism to pessimism.
And then back again. But in the long-run, the perspective is clear.
Emotions don't matter. Economics do.
We measure the economics of equity ownership
by what I call investment return, the dividend yield on stocks
plus the annual rate of earnings growth that stocks achieve. We
measure the emotions of equity ownership by the change in
the price that investors are willing to pay for each dollar of earnings
(the P/E ratio)what I call speculative return. Added
together, these two returns produce the total market return.
In 1983, for example, the starting dividend yield on the Standard
& Poor's 500 Stock Index was 5% and its earnings growth was
11%, an investment return of 16%. The price-earnings ratio rose
from 11.1 times, to 11.8 times, for a 6% speculative return. Result:
Market return for the year, 22%.
Long Term Investing is about Economics
Now let's examine these two sources of return over
the long run. Over the past 130 years, the market return
of U.S. stocks has averaged 9.0% per year. The annual investment
return from earnings and dividends has averaged 8.8%; the speculative
return just 0.2%. Were this a football score, it would read: Economics
88, Emotions 2. Long-term investing is all about economics.
That virtual one-for-one parity between economic return
and market return, however, is something we rarely see. Pendulum-like,
the cumulative investment return swings way above the market return,
and then way below. When emotions turn negative, and P/E ratios
fall, the speculative return sharply diminishes the investment return.
From 1961 through 1981, for example, a fall in the P/E from 23 times
to 8 timesfrom optimism at the beginning of the period to
pessimism at the endresulted in a negative speculative return
of minus 4.6% annually, slashing the 12.1% annual investment
return by almost 40% to a market return of just 7.5%
But fear can last only so long. In mid-1982, the
tables turned and optimism began to return. By the market high in
March 2000, the P/E ratio had soared to 35 times, an annual injection
of a full 5.4% of speculative return to the 10.3% investment return
of the 1981-2000 period. Result: Despite a 20% decline in investment
return, the total market return came to 15.7%, the highest
for any comparable period in history. Sometimes, emotions overwhelm
Does the reversion of the ratio of market return
to investment return to near parity mean that stocks are now fairly
valued? We don't know. We don't know because no one can be
sure how far the market pendulum, having swung so far toward greed,
may swing toward fear. What we do know is that since emotions
dominate the short-term decisions of most investors, the pendulum
rarely comes to rest at fair value for any prolonged period of time.
Further, we don't know because, given the strains our economy is
facing after the attack on America, there is considerably more uncertainty
than usual about the economic returns that lie ahead.
Financial Market Returns in the Coming Decade
But let's look ahead anyway, because we may know
more than we think. First, we know that the dividend yield component
of future investment return will be tiny. While over the long run,
the average yield of 4% on stocks has accounted for more than 40%
of the market's investment return, today's stock yield is but 1½%not
much gas in the market's tank. The second component, earnings growth,
has little short-term visibility as we work our way through a serious
recession in an uncertain economic environment. Corporate profits
are tumbling in 2001, and forecasting 2002 is an exercise in guesswork.
But the earnings of American corporations are likely to be
somewhat higher in 2005 than in 2000, and almost certain
to be much higher in 2010. Agree or disagree with my conclusion,
that's what the serious investor should be thinking about.
We also know that over the long term, the after-tax
earnings of U.S. corporations have grown apace with our population
and our productivity, and at a remarkably similar rate. Since the
end of World War II, for example, our gross domestic product has
grown at a rate of about 7%; so have corporate profits. Looking
ahead to the coming decade, a continuedif optimistic
earnings growth rate of 7% plus a dividend yield of 1½% would
bring the investment return on stocks to 8½%. It is these
economics that will drive the market.
Emotions seem more likely to reduce that investment
return than to increase it. With a price-earnings ratio of about
22 times based on normalized earnings (far higher relative
to actual earnings during the present recession), some retreat
toward the long-term norm of 16 times seems more than likely, producing
a negative speculative return of 1% to 3%. The result, if all goes
well: A stock market return in the range of 6% to 9% per year
over the next decade.
That may not sound like much. But don't forget that
the long-term norm is 9%, and that in one decade out of every three
stocks have produced less than 6% annually. And before you
write-off stocks, don't forget that prospective bond returns are
also low. The U.S. Treasury 10-year bond, for example, yields just
4¼% today, and money market fund yields will soon be below
2%. Wise investors will scale down their expectations to reflect
these new realities. My advice to long-term investors: Stick to
prudent investment principles; hold a stock/bond allocation consistent
with your own risk tolerance; and make sure your portfolio is broadly
diversified. Let economics rule your decisions, keep your emotions
out of play. And then follow the wisest of all investment rules:
Stay the course.
The Mutual Fund IndustryMeeting Investor
My outlook for financial market returns suggests
that the long and exciting voyage of the stock market is unlikely
to get less adventurous. We not only live in a risky era, but an
era in which lower returns in the financial markets, across the
board, seem the order of the day. But please don't make the mistake
of assuming that those are the returns investors will actually receive.
The fact is that few investors indeed ever have receivedor
ever will receive the returns that the markets provide.
This brings me to yet something else we know:
Since all investors as a group garner the gross returns of the market,
beating the financial markets is a zero sum game. And since
investing costs moneylots of it!all investors as a group
lose to the markets by the exact amount of their costs, and
beating the markets quickly becomes a loser's game. Because
of the staggering costs imposed by financial intermediaries, the
lag in investor returns is substantial.
Consider the mutual fund industry. Fund advisory
fees and operating expenses this year will come to about $70 billion;
sales charges and out-of-pocket costs, another $5 billion; the hiddenbut
realcosts of portfolio turnover, another $35 billion. Total
$110 billion. What is more, despite the industry's staggering
growth, these costs have soared even faster, for only a tiny portion
of the huge economies of scale involved in fund operations have
been shared with investors.
Since I came into this industry 50 years ago, fund
assets have grown by more than 200,000%(!), from $3 billion to $6.5
trillion. Yet the expense ratio of the average equity fund,
then about ¾ of 1% per year, has more than doubled, to 1.6%.
Fund portfolio turnover, 18% annually in those ancient days, has
risen to more than 100%, far larger than the decline in unit costs
that our highly-efficient electronic stock markets have provided,
and leading to an additional, say, 0.7% of annual costs. Together,
these two costs alone come to 2.3%. Add in fund sales charges and
other fees, and a 3% all-in cost hardly seems hyperbolic. All else
held equal, then, equity fund returns should lag the stock market
return by about 3% per year.
From Theory to Practice
Practice confirms theory. Since 1984, stocks,
as measured by the S&P 500 Index, have provided a 16.3% return.
The average equity mutual fund turned in a return of 13.1%3.2
percentage points less, a shortfall that closely parallels our three
percentage point estimate for fund costs. (Source:
Lipper. Fund data adjusted for sales charges.) In other
words, the funds earned about 80% of the market's annual return.
But when we compound the annual returns based on an investment of
$10,000 at the start of the period, the investor captured only 60%
of the market's cumulative wealth. The market investment would have
grown by $120,000, compared to just $71,600 for the average fund.
The magic of compounding investment returns; the tyranny of compounding
What is more, it's no secret that the fund industry,
once an industry that prized investment stewardship as its highest
value, has now embraced product marketing as its beacon. In their
battle to build assets, and thus advisory fees, mutual fund sponsors
are quick to capitalize on the latest fads and fashions of the stock
market. During the great NASDAQ bubble, for example, fund sponsors
created record numbers of new growth and aggressive growth funds
with a heavy tech-stock orientation (340 funds) and pure tech funds
(116), with pace-setting budgets advertising their pace-setting
short-term returns. These funds rose by an average of 85% during
the final upsurge in the market from 1999 through March 2000, and
those that were advertised had even higher returns.
The result: Great for the marketers, horrendous for
the investors. These aggressive funds were the recipients of the
largest glut of cash inflow in the industry's history$238
billion. On the other hand, investors in value funds, which rose
11% during the same period, actually had a net cash outflow of $29
billion. Then came the burst in the bubble. The growth group fell
51%, while the value group declined just 11%. It is no secret that
when a fund rises 85% and then drops 51%, its net return is not
34%. Its net return is minus 10%. ($1.00 rises to $1.85 and
then falls to $0.90). And the once-shunned value funds are down
1% on balanceafter all was said and done, an advantage of
nine percentage points. The message: Sweet selling is sour stewardship.
The counterproductive result of this business of over-marketing
and promotional hype is that the returns actually earned by mutual
fund investors are even worse than the inferior returns shown
in my earlier study. How much worse? Don't take my word for it.
Look at the figures reported by the fund industry's largest firm
(Source: Fidelity): With the S&P
500 providing an annual return of +16.3% since 1984 and the average
fund earning 13.1%, the return earned by the average mutual
fund investor was just +5.3%(!). Nearly 40% of the fund return
vanishes into thin air when we take into account where investors
actually placed their money. It turns out that fund investors earned
not 80% of the stock market's annual return, but 33%. And not 60%
of the market's cumulative wealth, but 12%, because the $120,000
profit earned by simply owing the market compared with but $14,000
for the average fund investor. Is the mutual fund industry meeting
the needs of individual investors? You tell me.
If mutual fund shareholders are the losers, who are
the winners? Why, the financial intermediaries! Specifically, the
owners of fund management companies, whose annual pre-tax profits
came to as much as $25 billion in 2000 alone. FORBES magazine's
recent list of the 400 Richest Americans gives us some idea of how
well fund managers do. The list includes 15 billionaires (or, in
fairness, near billionaires) whose wealth is derived from the profits
they have made by managing other people's moneyan average
nest-egg of $2 billion. It's a living! One can imagine that more
than one of these rich Americans owns a yacht of the type that inspired
the classic question: "Where are the customers' yachts?"
(Today, it may be a G-5 jet.)
If fund costs ate up a large chunk of the profits
of investors in an era of 16% stock returns, just imagine what will
happen when returns are lower. If I'm right that future returns
may be in the 6% to 9% range, a 3% cost would consume, not 20% of
the annual return, but 33% to 50%; not 40% of the cumulative profit,
but 75%. Fund costs will also take a substantial toll on that 4¼%
Treasury bond return and that 2% money market yield. So wise investors
had best be aware, not only that costs have mattered in the past,
but that costs will matter more than ever in the years ahead. Yes,
costs always matter.
Surely you can't look at the array of numbers I've
presented showing the shortfall of fund returns to the market without
wondering why on earth the investing public doesn't turn its back
on mutual funds and simply buy the market. I wondered about that
too. Indeed, a half-century ago, I wrote these words in my Princeton
University senior thesis on The Economic Role of the Investment
Company: Mutual funds "can make no claim to superiority
over the market averages," and mutual funds "should be
managed in the most honest, efficient, and economical way possible."
Given those convictions, it was clear that efficiently buying the
market averages at an economical cost would be a smart investment
strategy. But how to do it? The idea festered in my mind over the
ensuing 23 years. Suddenly the opportunity arose to take action.
Here we move from the odyssey of the stock market
and the odyssey of the mutual fund industry to the odyssey of Vanguard,
an adventurous journey that has been fraught with challenges but
punctuated by good fortune. After my graduation from Princeton,
I joined fund pioneer Wellington Management Company, and was named
to lead the firm in 1965. In 1966, I entered into an unwise merger
with some star fund managers. By 1974 they had tired of my autocratic
ways, even as I had despaired of their fall from grace in the sharp
stock market declinewhich was to reach 50%following
the burst of the earlier Go-Go bubble in the market. They banded
together to fire me, accomplishing the deed on January 24, 1974.
I was devastated. But I promptly set out to recoup
my job. In brief, I was able to persuade the directors of the mutual
funds that were managed by Wellington to set off on a new course:
Establishing a staff dedicated solely to the funds shareholders'
best interest; operating, not for a percentage fee but on an at-cost
basis; and giving the funds complete independence from the managers
who had fired me.
I named the new company after Lord Nelson's flagship
HMS Vanguardanother lucky breakand described our unprecedented
foray into running truly mutual mutual funds as The Vanguard
Experiment, a test of whether our novel corporate structure
and unprecedented form of fund governance that focused on profits
to fund shareholders rather than profits to fund managers
could succeed. In the words of author-economist Peter L. Bernstein:
Jack Bogle's goal was to build a business whose primary objective
was to make money for his customers by minimizing the elements of
the inherent conflict of interest (between seller and buyer), but
at the same time be so successful that it would be able to grow
and sustain itself. It has been no easy task.
Strategy Follows Structure
We were incorporated in September 1974, almost at
the very bottom of the bear market. Our asset base was $1.4 billion,
spread among eight mutual funds, all but one of whose portfolio
managers had performed poorly in the market decline. Money management
and distribution were still the responsibility of my former partners
at Wellington Management, and our new charter limited us to administration,
and nothing more. Our mutual structure would be key in our mission
to become the lowest-cost provider of financial services in the
world; our strategy would be to create simple mutual funds in which
low-cost was not only essential to investment success, but would
represent, dollar for dollar, the difference between success and
failure. Strategy follows structure.
We had been in operation for but three months when
the first seeds of that simple vision were sown. In July of 1975,
recalling the message of my thesis and the failure of our active
managers in the bear market, I collected all the performance data
I could find in old mutual fund manuals, calculated the average
annual returns of the 50-odd funds that had been in business during
the previous 30 years, and compared them to the return on the Standard
& Poor's 500 Index. Result: Average annual fund return, 9.8%;
S&P 500 return, +11.3%. To magnify that 1½ percentage
point difference, I assumed a large initial investment, and compounded
it. Thirty years later, the original $1,000,000 investment had grown
to $16,500,000 in the average fund, but to $25,000,000 in the S&P
500 Index. Difference: $8.5 million. Our mutual low-cost
structure gave us the ability to match the index at nominal cost,
and quickly led to our formation of the world's first index mutual
Our structure was also the linchpin of the strategy
to abandon our funds' half-century commitment to a seller-driven
broker distribution channel and move to a buyer-driven no-sales-load
channel in February 1977. We made that unprecedented decision just
five months after the index fund initial public offering was completed.
(It had raised a less-than-mind-boggling $11 million.) Ditto for
our second major innovation in fund management just four months
later, this time in the bond market. Casting tradition to the winds,
we formed, not a single so-called managed bond fund, but
a troika: Long-term, intermediate-term, and short-term. This simple
innovation, while less recognized than our creation of the first
index fund, changed the way investors regarded bond funds. It quickly
became the industry modus operandi. So, in less than two
years from our start as a tiny administrative company, Vanguard
had been transformed into the full-line fund complex it is today.
A lot has happened since the summer of 1977, but
nothing has changed the stamp of character we placed on the firm
during those formative years. It is the brute force of that character
that drives us to this day: Simple funds designed to assure investors
of their fair share of whatever returns the market is generous enough
to provide, no more, no less; low cost and no sales commissions;
a business strategy that departs from our structure at its peril;
and serving our clients and our crewmembers with the respect and
dignity that honest-to-God, down-to-earth human beings deserve.
Here is where we now stand:
- Vanguard's assets total $565 billion. At the outset,
we were the tenth largest fund firm; we now rank second, closing
on the leader.
- We had eight funds when we began; we now have 105,
owned by 15 million investors largely in the U.S., but scattered
all over the world.
- Our original index fund is now the world's largest
mutual fund, and our panoply of stock index funds total $180 billion.
Our market share of no-load stock index fund assets is a dominant
- Our original troika of tax-exempt bond funds, and
the similarly-structured taxable bond funds that followedall
relying on index-like strategiestotal $112 billion in assets,
including $24 billion in bond index funds. Market share:
Now 45%, vs. 18% in 1980.
- Our money market funds, also capitalizing on the
low-cost-equals-high-return equation have assets totaling
$93 billion. Market share: 33%, vs. 4% two decades earlier.
- And the assets of our traditional actively-managed
equity funds total $144 billion. Market share: 15% down from 25%,
the inevitable result of our focus on indexing.
The magnificent returns in the financial marketsstock,
bond, money market through most of our history, really right
up to the spring of 2000, have given HMS Vanguard a powerful wind
at her back. Our assets have grown at a compound rate of 25% per
year, and at a remarkably steady pace, carrying our asset base from
$1 billion to $565 billion. But the overwhelming portion of that
huge increase has come from our rising share of market. Had our
share held steady, our assets today would be $110 billion. The remaining
$455 billion is accounted for by the increase of our share of total
industry assets from 1.7% in 1981 to 8.3% todaywithout a single
year of decline. This rise in market penetration has been accomplished
with but a modest marketing budget, for I have always insisted:
Market share must be earned, and not be bought.
Looking AheadA Personal Note
As we look back over the three adventurous voyages
I've described this evening, it's worth speculating about what may
lie ahead. For the stock market, the odyssey is destined to continue,
but the two easy golden decades we have reveled in are now history,
and the voyage will be rougher and slower in the years ahead. For
the mutual fund industry, the odyssey is already waning, and its
course willas it mustat last turn away from high-costs
and fad-following, back toward our original roots of prudent management
and stewardship. And for Vanguard, our fantastic odyssey, which
has already helped to change the way people think about investing,
will proceed with even greater alacrity in the years ahead. Unless
I miss my guess, in the financial markets and the fund industry
alike, we're facing an extended climate of Vanguard weather.
After 50 years in this business, the last 27 with
the renegade firm I created all those years ago, I close with a
few personal reflections. Peter Bernstein was right. It has been
no easy task. The road has not always been smooth, and I've
experienced headaches and heartaches, hopes and fears, delights
and disappointments, even triumph and disaster. But, following Kipling's
advice, I've treated those two imposters just the same. Truth told,
I look with some bemusement about how far one can take an enterprise
with common sense, a few simple ideas, a heavy dose of idealism,
a focus on serving human beings, a fantastic crew, and a determination
to press on regardless.
It's been a thrill to see a company that offers little
more than simple investment philosophy and simple human values become
a commercial success, but even more, an artistic success.
I press on in the great cause of giving Vanguard shareholdersand
all mutual fund investorsa fair shake, and I reflect on my
own odyssey with the words Tennyson ascribed to Ulysees when that
mythic warrior returned from his own odyssey and reflected on what
might be next:
So come, my friends
'Tis not too late to seek a newer world.
Push off, and sitting well in order smite
The sounding furrows; for my purpose holds
To sail beyond the sunset, 'til I die.
Tho' much is taken, much abides; and tho'
We are not now that strength which in old days
Moved earth and heaven, that which we are,
One equal temper of heroic hearts,
Made weak by time and fate, but strong in will
To strive, to seek, to find, and not to yield.
Note: Unless stated otherwise, all return
data are through 10/1/2001.
Note: The opinions expressed in this article do not necessarily represent the views of Vanguard's present management.
to Speeches in the Bogle Research Center
©2006 Bogle Financial Center. All Rights Reserved.