Meet the Founder of a Trillion-Dollar Mutual Fund

John C. Bogle is the founder and retired CEO of The Vanguard Group,, the largest mutual fund organization in the world, comprising more than 160 mutual funds with current assets totaling more than $1.4 trillion. Since his retirement from Vanguard in 1996, Bogle has spent his time studying, writing, and speaking on the financial markets and mutual funds. He is president of the Bogle Financial Markets Research Center, created in 2000 to support his ongoing work on behalf of investors.

Bogle joins Tom Gardner for a discussion of Vanguard's creation -- at a time when Wall Street was suspicious of index funds -- and shares his views on individual investors, the gambler's instinct, and long-term investing.

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Tom Gardner: Thirty-nine years ago, almost to the day -- a little bit longer than 39 years ago -- you started The Vanguard Group. Jack Bogle, one of our heroes at The Motley Fool for so many different reasons -- which will come out, hopefully, in our conversation.

It starts with simplicity and clarity, integrity, and a solution that is transparent in a financial industry that works so hard against those qualities, it seems, many times. What was life like for you in 1974? Can you paint a little bit of the picture of what Vanguard was then, compared to what it is today?

Jack Bogle: Sure, and this will not be very surprising to anybody that's ever started what we call in the modern age -- we didn't use the term then -- a "disruptive" technology. We were shrinking. When we finally broke up the Wellington Management Company into certain operating units and Vanguard took over the administration, we were going downhill.

One of the directors said, "Bogle, do you realize we're hemorrhaging?" Realize it? We had more money going out than coming in for 83 months! You've got to be kind of blind, you've got to be kind of stupid, and you've got to think it's great news when a month's cash flow goes from $20 million out to $19 million out.

Everybody condemned the index fund. Ned Johnson said, "Our shareholders would never want a fund with average performance."

Gardner: "Mere average."

Bogle: By the way, that was the year -- 1976, probably -- when all the Fidelity funds had fallen out of bed, and they weren't getting anything like average performance, just for the record.

For whatever that philosophical bent was on his part -- nice enough to say -- they now have a $150 billion index fund business, so we've seen this huge swing.

"Help stamp out index funds. Bam! Bam! Bam!" -- that big Wall Street poster. Everything was negative. The Wellington Fund had been just about destroyed by our partners from Boston, from an investment standpoint. That was the flagship of the Vanguard fleet, and it dropped from $2.1 billion to $400 million. The performance was the worst in the industry for any balanced fund.

There wasn't a lot of good news around. All the funds that were part of the merger went out of business -- the Ivest Fund, finally -- funds that people had never heard of ... the dustbin of history, we say. One called Technovest, using technical market analysis -- yes, Wellington bought out such a fund -- and a fund for trustees called Trustees Equity Fund, the first one. It crumpled like tissue paper in a fire, to pick a metaphor!

So, everything was bad. You had to know you were right in the long run. You had to know that gross return in the financial markets, minus cost, equals net return. Pretty smart here -- that's the underlying principle.

I didn't really phrase it this way in those days, Tom, but when you think about it, we're all indexers. Every investor in America is an indexer because 25%-30% -- let's call it 25% -- is indexed, but the other 75% own the index, but one at a time. That's the total market, and if you have the total stock market fund, you either own it as a unity or you own little chunks of it and somebody else owns the rest.

Will the unity, let's call it the "unity business," of the index fund do better than the trading business, for all these other people that own the index -- trading with one another -- and try to outpace them, which of course can't be true, and they pay their little helpers, and therefore they have to lose.

It's all so clear that it is a disruptive technology, and it works. But any time you try to introduce a new idea first it's, "It will never work." Then, "It will work, but only for a short time." Then, "The guy's really lucky." And finally, "You know, he's right."

Gardner: Do you think, during the "guy's really lucky" phase -- or is there a phase in there -- where it is "the guy's a threat and we're going to say whatever we can to confuse people about the solution that he's putting in the market"?

Bogle: Well, they can try that, but it's too late for that. It's too late.

In the last five years, roughly, $400 billion has gone out of actively managed funds and $600 billion has gone into index funds. It's a trillion-dollar swing, just for the equity part of the business. It's probably around $6 trillion or $7 trillion. It's a huge swing in five little years -- so the market is responding.

Even the people that don't like it at all are doing it, because the client insists on it. Part of the insistence is going in the wrong direction -- and that is, we have the ETF, which is a way of trading the index fund all day long, in real time. What kind of a nut would do that?

Gardner: Well, there are a lot of nuts out there, right?

Even though there's been a tremendous growth in index fund assets, simultaneously there's been a complete diminishment of long-term investment, as a principle that is both adhered to by individuals, by professionals, covered in the financial media that way. The average holding period for a stock or a fund, or holdings within an actively managed fund's turnover ratio is north of 100%.

Bogle: It's actually much higher than that when you look at the cost of it, because that's the lesser of the portfolio's sales and purchases, that you count as the amount of turnover, and then divide them into the assets of the fund.

The fact is, whether it's more or less -- or even the same -- you've got those two sets of transactions. If you take money out of a stock, that costs money. Then you put money back into another stock, and that costs money. So, the costs are very, very high. The unit costs, in fairness -- the costs from trading a share -- used to be maybe $0.30 or $0.25, in the old days, and now they're probably less than a penny. But if you're trading 500 times as much ...

Gardner: Is there anything good about trading, in your opinion?

Bogle: Well, yes. I think the market needs a certain amount of liquidity, and I accept that. But how much liquidity do we need? Do we really need the market to turn over 250% a year? I grew up in this business. There wasn't a liquidity problem, and the turnover was 25% a year.

I've been known to say -- you'll like this expression -- copying Samuel Johnson on what he said about patriotism: "Liquidity is the last refuge of the scoundrel."

Gardner: And the scoundrel is transacting that frequently because ...? What's motivating them? It's human nature, and they're blind to what they're doing? Or there's a built-in conflict of interest that's causing a professional to transact either in their retail clients accounts, or for reasons inside their fund?

Bogle: Well, first, there's a lot of ego out there. Even someone you know has a pretty big ego, but he doesn't use it by saying, "I'm smarter than other investors." But we all think we're smarter than the other guy. We all think we're better drivers. Sometimes I think we all think we're better lovers; I don't know about that. But we're all average -- we know that -- and have to be, and will be. No Lake Wobegon here in the investment business.

Then we have this massive marketing machine of paid salesmen who can always beat the index. Because if you've got a universe of 500 funds and someone says that they want the index because it does better, "Your problem is you're looking at the average fund. I will give you a fund that's above average."

It's always easy to do -- very easy to do. For some period, for some fund, it's the easiest thing in the world to do. It's a sales machine, and they have conviction they're doing the right thing, but they've got to know, deep down, they're not doing the right thing.

Gardner: Now, there have to be some you believe are doing the right thing on the active management side. There have to be some investors that you've encountered over time that you think it's admirable what they're doing, and actually that the results -- insofar as we can draw a conclusion off a single sample of one person's lifetime -- appear to be above average, sustainably.

Bogle: Well, I'm not sure "above average" is quite the standard, and that's a really tough standard to meet -- but you can do a perfectly good job. The managers I like, and I don't hesitate to say who they are; you can look at Dodge & Cox and you can look at Longleaf, and there are probably a number of other small firms.

What's so good about them? They are in the business of investment management, and not in the business of marketing. This has become a great, big marketing business, and they stick to their guns and they manage money.

They slip. They stumble. They err. They make mistakes. This is a business, for all that. But in the long run, I would bet on someone whose business is trying to be a professional investor -- not a trader -- someone whose business is trying to serve you, rather than serve the marketplace.

There aren't a lot of them -- and I don't want to put a curse on them -- because they'll get too big and they won't be able to do it anymore. That's one of the great secrets of this business -- and that is, if you're really good for a long enough time, you draw an awful amount of money, and then you can't be good anymore.

Gardner: Too big to succeed.

Bogle: Too big to succeed, or, as Warren Buffett says, "A fat wallet is the enemy of superior returns." And of course it is.

If you can get someone who can give an index a good run for its money, I wouldn't say you're going to do a lot better. I don't think they would say you're going to do a lot better. But it's a good alternative, because you don't know it all; there's an infinite number of choices. I think Longleaf probably runs four or five funds. Dodge & Cox runs five, I think. The rest of us -- Fidelity runs 260 funds. Vanguard runs, I think, around 170. I'm not sure anybody really knows, and that's tough on a whole lot of levels.

Gardner: Can you describe, fundamentally, how an index fund works for somebody who is watching and owns a Vanguard index fund? How does the process work behind the scenes? Is it five robots, three monkeys, and a bunch of data, or are there human choices that are going into the index?

Bogle: Well, first, you can match the index in a very casual way. If Microsoft is 2% of the index, you just put 2% of the portfolio in Microsoft. And the same thing is true of every other fund; not very complicated.

If you don't do it with great professional skill and all kinds of quantitative support, you will do a perfectly good job, but not a perfect tracking job. In the long run, you'll match the index, but you might beat the index by 50 basis points, half of 1% in the year, and lose to it by half of 1% in another year. The tolerance is very small.

Our investors like to see a tight tracking, so you do all these quantitative things. They call for quantitative mathematical skills, particularly when there are additions to the index or subtractions. That happens more in the Standard & Poor's 500 than in the total stock market.

It's a very simple thing, conceptually, but to do it with something that approaches perfection is just what you say; a lot of quantitative people, hidden behind the walls.

Gardner: If we take the concept of "too big to succeed" and apply it to a capitalization-weighted index fund, isn't that a bad idea? Wouldn't it be better to set the index fund up on a different set of criteria, rather than weighting it by capitalization?

Aren't we buying the largest companies and the most successful companies, which should have the smallest future market opportunity, and underweighting the small, potentially upstart, disruptive future Vanguards?

Bogle: Well, you're saying that the cap-weighting indexes give you a flawed index, in effect.

I guess my first comment would be, since such an index beats the heck out of money managers, what kind of trouble would we be in if there were a perfect index? Then I'd also say, much more importantly than that; the idea of indexing, as Paul Samuelson described it when he wrote the foreword to my first book, was, "You will get better returns than your neighbors and sleep better than your neighbors" -- and your neighbors own the capitalization-weighted index.

Now, will a value-weighted index do better? Will a dividend-weighted index do better? Probably it will do better some of the time. I do not believe it will do better in the long run. That remains to be seen.

But when you think about it, if "fundamental indexing" -- whatever that means exactly, but a weighting by some corporation data, rather than by market price -- still owns essentially all the stocks that the S&P 500 owns, with just somewhat different weights; not huge, but somewhat different weights. They may do better, they may do worse.

But if they continue to do better, what will happen? Everybody will take their money out of the market-weighted index and put it into the value-weighted index, and then the opportunity will vanish. That's the way the markets work.

I don't think it's going to work, and I don't think that it's worthwhile to add that risk. I know what I can get. I can do better than my neighbors. I can own the whole market -- that's a little beyond the S&P, but that's a perfectly good way of looking at it -- do better than my neighbors.

Should I give that -- let's call it "certainty of relative return" -- up for the uncertainty of whether one of these schemes that's out there? Equal weighting, value weighting, dividend weighting, fundamental weighting, all kinds of weighting ...

Gardner: I feel like equal weighting would be smart, but I guess time will tell whether that plays out.

Bogle: It works sometimes; we have data going back forever.

But don't let past data impress you. When people start actually doing these things -- you know this from your own experience -- what comes out of the lab is seldom reflected in the real world.

Gardner: Let's say somebody is indexing entirely. How many funds should they own, as an individual? What's too many and what's too few?

Bogle: You can certainly do it with one, and that would be something like the Vanguard Balanced Index Fund. It's 60% total stock market, 40% total bond market, both U.S. That's fine.

Gardner: A person out there could simplify their lives; make sure they're paying off all their high-interest debt -- it's gone -- they're saving a portion of their salary each year, and they're putting it all in the Vanguard Balanced Index Fund. That three-step approach is going to improve the outcomes for the majority of investors out there, number one, and you think it's completely reasonable to put it all in a single fund.

Bogle: There are obviously a lot of nuances here, and one of them is if you're younger I would think you would want to be 80%-85% equities, and if you're older I would think -- although interest rates are so terrible today you have to rethink all these things as the markets change -- but older maybe 25% equities and 75% bonds, something like that.

This is kind of age-based -- your bond position should equal your age -- but that's a rule of thumb and, interestingly enough, it shows a gap in the way these target-date funds, that are very popular today, are structured, because they ignore the fact that 85% of their shareholders have Social Security.

And Social Security, when you begin it, has capitalized value -- the stream of future payments you will get that is capitalized at around, say, $350,000 -- if you have $350,000 totally invested in an equity index fund, you're 50/50. You don't look at it that way, and your behavior may get you in trouble that way, because you've got too much in stocks.

What people should be doing, honestly, Tom, is stop looking at the silly stock market every day and look at the cash flow they get.

Social Security; those payments are going to continue. They're going to grow with the cost of living. I'm certain -- as certain as I can be -- that Social Security will be repaired, simply because it has to be. I don't think its future is in doubt, if we can just wake up a few of those people down in the nation's capital.

For stocks, you probably want to look at more of a dividend bias. You could buy a high-yield dividend index instead of the total stock market index if capital flows. That dividend -- if you look at the stream of dividends -- it makes the stock market look violently volatile. The dividend stream goes up, up, up.

The fact of the matter is, there have only been two significant dividend cuts since 1925. One was in '29-'32, and the other was a few years ago, 2007-'09, when all the financial companies pretty much eliminated their dividends. We've already recovered from that -- that's over. The Standard & Poor's index is paying more dividend now than it was before the drop.

All of these things are clear in the past, and, in a lot of ways, that doesn't matter. But if you assume that American business grows and America grows, that dividend stream will keep going up -- and as people ask all the time -- corporations have got huge amounts of cash so dividends should not be jeopardized, absent some real problem in the world and in the economy. People should be aware of that.

Nothing is a lead-pipe cinch in this world. Actually, it's sort of amusing! You have a couple of big risks out there. You know about the economy. You know about the international, kind of hanging on by its own. You know about the dollar. You know about the Federal Reserve buying all those securities and trying to bid the prices up of assets -- not a particularly wise move.

You have to assess those risks and try to make some kind of a judgment, however difficult, about how they come out. But you also have to realize a couple of things. The second set of risks is really the incomprehensible risks, like nuclear warfare or a meteorite hits the U.S.

Gardner: Or robots begin to control our society.

Bogle: It won't matter whether you have stocks or bonds or anything else.

Gardner: A club. You'll need a club.

Bogle: Yes, just a club.

There are all kinds of big and small risks. But, as I've often said, we're sitting here knowing the world is going to hell in a hand basket, but people have been worried about that since the beginning.

Gardner: The known fears are not the ones to really fear.

By the way, Jack, I truly can't believe that you're 84 years old. Are you 84% in bonds?

Bogle: No.

Gardner: So you're violating your advice. I'm kidding!

Bogle: You know, it's my rule of thumb. And of course, at 84 your Social Security doesn't have a capitalized value of $350,000, either! I'd like the next check to come in. My wife doesn't think we should take the checks, but we postponed them until we were 70. I could live on what I get from Social Security, because we live in a fairly modest way -- well, very modest compared to the standards of what you see in the financial world and corporate world -- but pretty nice compared to the typical American worker.

You start with a rule of thumb.

Gardner: Then you work back.

Bogle: You work back. And I haven't figured out, Tom, how to do it. When I first introduced this rule ...

I can remember back in 1999 at Morningstar, I told them that I was reducing my equity position from about 75% of my holdings to, I think 30% of my holdings, because the stock market was selling at 35 times earnings and the bond market was yielding 7%.

I looked at the transcript a while back and I said, "Honestly, when I look at the math, I don't see why I would hold any stocks at all, because at 30, 35 times earnings, stocks were not going to give you a 7% return in the first decade of the 21st century."

Gardner: Now you look at the numbers, and you're not really sure what to do about them.

Bogle: Now, my own position is that stocks are more or less fairly valued -- probably a little on the high side -- but more like, depending on whose number you're using, 15 to 17 times earnings, maybe 18 times earnings. It's a long way from 35 -- half.

And bonds are not yielding 7%. They're yielding -- depending on what you want to look at -- 2.5% to 3.5% depending on corporate government mix, maturities and things of that nature. So, you have to think a little bit differently, but I have not done anything about that. I don't change my portfolio.

Gardner: I want to talk a little about financial advice and how that side of the business works, because Vanguard is at least perceived to be exclusively a mutual fund company, so a lot of individuals are trying to figure out how to put a portfolio together. It's helpful to hear the number of funds that you would put into an account for an individual, and it's relatively small.

It should be manageable, and a decision an individual can make on their own. Yet, many people come to their financial advisors and say, "Please, Jack. Just do it for me. I'll literally give you the authority to make all transactions in my account. I don't want to know anything about it." This, of course, sets up a lot of people to be taken advantage of by financial advisors. What do you think of the financial advice side of the decision-making process?

Bogle: First, let me take this -- maybe you think it's kind of a nuance -- but I got a letter from a shareholder the other day saying, "You keep telling me you only need three or four funds. Why do you have 170?"

I took this simple example for him. We have like 60 bond funds ... 60. Why is that? Well, we invented, or created, or developed, a system of "You tell us the maturity" -- how much risk and income you want -- so you've got short, medium, and long, and also a couple of variations around that.

Then in the municipal area, you not only have the funds themselves, but you're dealing with different states. Then we have some bond index funds. We probably have 60 bond funds out there.

An investor either has to know and do the math -- should he be in municipal bonds or in taxable bonds? It's a very important decision. Right now, municipal bonds look very attractive, simply on those kinds of numbers.

Then you have to decide how you want to balance risk and return. Obviously the higher yields, no matter how depressed they are, are in long bonds, but the greatest risk is there. And the lowest yield is in short, but the greatest principal stability is there. Those are decisions that investors really have to think a little bit about.

You can buy the bond index, to be sure, and that turns out to be an intermediate-term bond fund, in fact, and that's perfectly satisfactory.

But we nuanced ourselves to death a little bit. You should, in terms of taxable and tax-exempt, deal with that issue. I'd say, to simplify, most investors should be in tax-exempt, just because they yield significantly more than Treasuries, even before you take into account the tax exemption. I think they're attractive. Now, maybe you want some Treasuries there as your bulwark, and you buy a Treasury Bond Fund. It gets to be a little nuanced.

I think the interesting question is, if you want financial advice, how much should you pay for it? Let me give you an interesting piece of math. I look at the stock market investment return as a 2% dividend yield at the present time -- low but not nearly as low as the 1% we were -- and a 5% earnings growth.

That's a 7% investment return and over the next 10 years, I don't think it's going to go up because of higher P/Es or down because of lower P/Es; not down much, anyway, so there won't be any speculative return, at my reckoning. So, we've got 7%. That's nominal.

So, we go to real. If we're lucky enough to get 2% inflation, that's 5%. A typical fund manager is taking 2%, that's 3%. If you give 1% to an investment advisor, that's a third of 3% and you're down to 2%.

Gardner: That's brutal.

Bogle: If you're a fund picker, you lose around 2% by jumping on the latest bandwagon, and 2% minus 2% is a number that I won't recalculate for your audience!

Gardner: It's a reminder of Warren Buffett saying that the financial services industry is an extractive.

Bogle: Sure. The economists call it a rent-seeking industry. Of course it is. It has to be.

It has to shrink, and it has to get its costs down. The trading volume has to come down, and a lot of mutual funds -- they're going to be cash cows. The big mutual fund companies are fantabulously profitable. They can't change what they're doing and do what we do, because they would not be profitable for their owners.

Either financial conglomerates, or all those partners at the Capital Group, or the Johnson family up at Fidelity, their wealth is like $20 billion or something, putting the family all together. They've done great in this business. Whether their shareholders have done great is the question that interests me. That's where we should be focused.

And the financial conglomerates are the same thing. They basically tried to destroy this industry; 40 of the 50 largest fund groups are publicly held, and 30 of them by financial conglomerates. Think about buying a fund that's run by a financial conglomerate. Why did they buy their way into this industry?

Gardner: And why are there more funds ...?

Bogle: The Golconda. They wanted to jump on the wealth bandwagon of managing money, and they will accomplish that whether by hook or by crook. If their return capital threshold is at 15% and they pay a billion dollars for a mutual fund company, they're going to have to take out $150 million a year -- and it's easy. There's all kinds of things you can do to make it up.

Gardner: You're a fan of capitalism.

If we look in the marketplace in finance and compare two actors out on the stage, one of them is a fee-only fiduciary financial planner with a basic flat fee dollar amount that sits down and builds a Vanguard-based, indexed, low-cost portfolio, acting as a fiduciary. The other is a financial advisor or broker.

I'm reminded of three that came to a book signing of ours in San Diego years ago and said, "You talk about the Vanguard Index Fund. It's really funny you say that. We now manage money. We've left the firm that we were at" -- in their case they were at Merrill -- and they said, "We couldn't sell the index fund to our clients because we couldn't make any money on it, but we all owned it ourselves."

It's the complete reversal of the fiduciary. It's like, "I will be fiduciary for myself," and then fiduciary with my relationship with you is, "If you're willing to buy what I'm selling, then I haven't done anything I should feel badly about."

The reality, though, in the marketplace is that the first actor -- the fee-only financial fiduciary -- is living a relatively lean existence in terms of the financial makeup, and the VP of the big investment firm has a country house and is making $1 million a year selling load funds and a whole bunch of booby traps in the portfolio to keep you locked into different products. How do you observe, and what conclusions do you draw, about capitalism given that?

Bogle: Capitalism has a very funny manifestation when you get to the fiduciary duty of managing other people's money.

With most systems -- particularly when you begin with a new idea -- if you want to get it sold, you pay the salesman a lot of money, you advertise a lot, and you deliver 70 cents on the dollar, or something like that.

The investment business is really a business of mathematical candor. You can't hide. If you're selling a Mercedes-Benz, the salesman selling it is going to say, "Look at the value you're going to get. Your neighbors are going to be envious, Blah, blah, blah," whatever it is. And you like the diesel fuel, or the door slams nicely, or it's got a great sound system, or air conditioning -- I don't know what.

But in the financial business, value is one thing: dollars. It can be measured, unlike all these esoteric things that characterize capitalism. And once you get to measuring value, the problem becomes a very simple mathematical problem.

Now, how you get people to focus on that is a good question. How do you get them to focus on the role of cost in that, is a good question. How do you get them to think about the long term? Because in two or three or four years the difference in cost -- let's face it -- just doesn't matter.

But, over your investment lifetime, getting the market return in an index fund, or almost the full market return, compared to paying 2% -- which is roughly the right number for a managed fund -- means that you get, in the latter case, about $0.30 on the dollar; $0.30.

But you've got to look at 40 or 50 years. But these young people today ... say they're 25; 50 years is 75. That's too short! They'll live to 95. They should be looking at 70 years, and these numbers just get further and further apart.

A lot of people do need help, there's no question about that. But I think we have to rethink how we pay for that help. It may be that 1% is much too high -- although if you have a client with $25,000, 1% probably isn't nearly enough.

I think eventually you'll have a fee-for-service kind of thing, like a typical professional service -- lawyers, accountants, and so on -- neither profession of which I'm particularly smitten with! They have gone that way, and that's the way they conduct their business. It's more of a professional approach than a business approach.

But don't try and get me to tell you there are easy answers to this. You need help out there. People need their hands held. There's no question about that. Paying a little bit for it is probably better than doing nothing and just trying to do it yourself. And the worst thing of all is not investing at all.

That is the one guarantee we have in the financial business. Well, there are actually are two. One is, if you buy the index fund you'll get the market return. Guarantee two is, if you don't invest, you will get nothing.

Gardner: Let's take the family that I was raised in, which taught us from a relatively early age to buy stocks directly. I'll make the argument on behalf of it. Then one of our members, Neil, wants to know what you think of that argument -- where you see strengths and weaknesses to it -- and feel free to knock it down entirely. You'll just be knocking my whole life to the ground if you do!

Bogle: Oh, will I really be doing that?

Gardner: No!

We were raised in a family and taught to invest in stocks. It was a low-cost alternative, a one-time payment. I guess one of the primary pieces of advice I give to any investor who's buying stocks is, "Double your holding period right now" -- and if you want to do it, right after you've done that, double it again -- because just as with a great fund, a great business should be held over at least five years to really see the value of that organization play out in the marketplace.

We were taught to buy stocks -- the low-cost, one-time transaction; find the great businesses with a great leader. Howard Schultz has been in Starbucks, John Mackey at Whole Foods; these businesses have compounded incredible returns since they became public 20 years ago. Hitch your wagon to the stars of these really great, often consumer-facing, businesses that we can follow.

You have to do a lot of numerical work and valuation, etc., but that's how we've been building our portfolios in our family.

Neil wants to know when it is appropriate, in your opinion, for an individual to buy stocks? Is there a level of expertise or interest? An amount of time you should have, or capital? Or should it be a side frivolity in a base portfolio of index funds?

Bogle: That last sentence captures it best.

That is, you should have a serious money account -- I might even call it a boring money account -- where you put money in a stock market index fund and balance it a little bit with some bonds, depending on age and so on, and don't look at it. Don't look at it for 50 years. Don't peek.

But when you retire, open the envelope. Be sure a doctor is nearby to revive you. You'll go into a dead faint. You can't believe there's that much money in the world. That's where we fool ourselves. That's a serious money, boring money account.

We have a gambling culture here in this country. Maybe every country does. You see it in its finest manifestation -- or maybe I should say worst manifestation -- in the state lotteries. Las Vegas contributes its share. The races contribute their share, the track.

All of these are just gambling, where a whole lot of people bet their money, and a whole lot of people take their money out and the croupier wins. The house wins.

Gardner: Three to 20 percent of whatever has been bet.

Bogle: Of whatever it is ...

Gardner: You put a dollar in, you're going to lose ...

Bogle: I'd say if you have a gambling instinct -- and most people do -- at least start off in an index fund, period, and for five years don't do anything else.

Then look around. See what's happened in the five years. See how you felt when the market dropped 50%. See how you felt when it came back. And those five-year periods are going to be very different for one investor and another, because they're all over time.

Then, when you get there, 5% in the funny-money account.

Gardner: What would have happened to Warren Buffett if he had done that? A tremendous amount of value would not have been created by his understanding and ability to evaluate a business for investment.

Bogle: Well, name two.

Gardner: Well, Longleaf. You mentioned Longleaf. Dodge & Cox.

Bogle: Well, but they don't have the sensational returns. They probably have something above par returns, but maybe a little below par from time to time.

Then don't forget, in Warren's case, he wasn't running a mutual fund. The mutual fund is a badly structured business for investment management. We say -- and this is the way it has to be, really -- you can take your money out whenever you want, and you've got to be ready to put it in whenever you want, and so you ride on these waves of optimism and good performance. The money comes in up here and then reversion of the mean -- which is a big part of the final chapter of my recent book, called Clash of the Cultures.

And it's happened everywhere. It's happened in the Magellan fund. It's happened in the T. Rowe Price Growth fund. It's happened in our old Ivest fund. It's happened in the Fidelity Trend fund that Ned Johnson happened to have run. It happened in the CGM.

All the hot funds -- they were all in there for the last 25 years and, they all look like this. You put them over each other, it looks like the Himalaya Mountains. The reversion of the mean is a constant pattern.

Gardner: For the individual -- I'm just going to poke around here a little bit, just to get your full philosophy -- it's unlikely you're going to hit the mountaintop of the Himalayas with your portfolio. You may not have to ever see the other side of the mountaintop, unless you have so successfully invested that your personal account is moving up in the billion-dollar ...

Bogle: Let's say you bought Magellan before it was for sale -- which is where that record begins, by the way; there's a lot of phoniness in this business. You're going to enjoy the mountain, and you're not going to know it's a mountain. But when that mountain gets up there, you think, "My, God. I found the Holy Grail!"

Gardner: "Now I'm really going to go all in."

Bogle: "... And now I'm going to go all out." There's a lot of behavioral kind of stuff -- not to use too fancy a word -- in the mutual fund industry.

Interestingly enough, Tom, there is no behavioralism in the field of stocks generally. How could that be? That's because I'm a dumb behaver. The guy that buys my stock from me is a smart behaver. We offset each other. It's not as if I can make a behavioral mistake without somebody else making a successful behavior on the other side of the trade.

I think we take a lot for granted. We listen to all these theories, and big, old, boring indexing is the answer.

Gardner: Have you ever bought individual stocks and/or actively traded funds -- and if so, what do you look for in those investments?

Bogle: Well, when I came into the business, I had friends in the brokerage business. I bought this and that and the other thing. Then I had a broker; he would tell me this was good, "Get out of that and get into that." It wasn't that they did badly -- which was, of course, what they did -- but it was that I just couldn't stand to have my phone ring when I was trying to do my work.

So, I haven't owned individual stocks since, let me say, 1960 -- I don't know exactly -- a long, long time. I've never bought anybody else's mutual fund, although I did buy a nice back-up investment for my son John -- Bogle Small Cap Growth -- and it's done rather nicely, of course. He's very smart! That's about it.

Gardner: Even the most successful, actively traded funds at Vanguard have a period of three years -- sometimes even five years -- where they underperform, but net-net they've outperformed.

In the case of outperforming actively managed funds, let's just say they have a few qualities that we probably both love: very low turnover, tenured leadership, a very fundamental business-analytical approach.

But even in those cases where the fund is very well run -- even Warren Buffett and Charlie Munger -- are going to have a year or a period of a couple of years, potentially, where they lose to the market. What's the appropriate amount of time to hold something before saying, "This team doesn't really know what they're doing?"

Bogle: Well, let me start off by explaining Vanguard's philosophy as I implemented it -- not as they necessarily do today.

That is very early after we closed Windsor Fund back in 1985 --- it was getting too big -- and we started Windsor II. Everybody said it would never do nearly as well as Windsor, and of course it's done better, a little. They track each other very closely, so I don't want to make an issue about that.

Then we had U.S. Growth, and that was run by Wellington. We decided we needed a new manager, and I wasn't so sure about them, so I did what set the standard for everything I did since then, and that is bring in another manager, and then another manager, and then another.

We have a lot of equity funds that have five managers. It's not that it's easy to pick five managers, but if you're comparing yourself with the universe of -- let me say -- large-cap value funds, and there are 50 funds in that universe, five is going to have the same return. It's a law of large numbers thing.

Most of our equity funds have five to seven managers, so there's not much premium on manager selection. You hope they will do well. We happen to be having a good year this year, but we'll have a bad one because that's the nature of the business.

What you don't want is something that departs so far from the market -- particularly on the upside -- I mean, you don't like it on the downside, but on the upside it draws money in. It brings in these investors who are looking for the next big thing, the next hot thing.

We win by about a point and a half a year, on average, not because we pick better managers, but because we have very low operating costs -- our expense ratio. We negotiate the fees way down with the advisors -- the fee rates -- because the advisors are not starving to death in terms of the dollar fees.

Then we've looked, as you said, for long-term managers with lower turnover, and then we have no loads. If you look at all those numbers if we're good enough to be average -- or lucky enough to be average -- we win by about a point and a half a year, which is 20% over 10 years, and I always thought that was quite good enough.

Gardner: Just a few more questions. Is there ever a situation that you can imagine where an individual should own a load fund? They've sat down with a financial advisor. They watch this video, and they're looking though their portfolio as we're talking, and they see a number of funds that their advisor has put them in that carry a load. Is there ever a situation they should be happy about that?

Bogle: I'd say unequivocally not. The advisor is going to sell you a load fund and say, "This no-load stuff is bunk. Here's the no-load index and this fund, even counting the 5% commission" -- which is roughly where they are today, although a lot of that has changed to advisory fees -- "even with that 5% commission, we did 50% better."

Well, hindsight is always 20/20. If they can't find a fund that beat the index, they can't be very acute. They can't be paying much attention. It's the easiest thing in the world to do!

But don't believe it. The past is not prologue, and actually if you look at the numbers carefully enough and long enough and thoughtfully enough, you'll see the past performance of the fund is anti-prologue. The better it is in the past, the more the regression to the mean; the greater that's going to be in the future.

Gardner: Do you believe that we will have a unified fiduciary standard or not? Are you optimistic about that? 

Bogle: Let me just say this. The issue is a very narrow issue at the moment, and that is the fiduciary standard for people who are selling funds -- investment advisors, fee-only investment advisors, stockbrokers, things like that; it's the firing line level -- I think we are making a very big mistake. I've written to the SEC three times about this, and that is the biggest problem on the fiduciary side is in the fund manager side. We need a federal standard of fiduciary duty for fund managers.

Look at what's going on at the Labor Department, and I've talked to them down there about this. You look at the fiduciary duty for a corporation and for the evaluator and for this one and that one -- but no fiduciary duty for the guy where you really need the fiduciary duty -- the fund manager.

We do need fiduciary duty. That would tend to get us out of this morass we're in of short-term trading, of high costs, of speculation versus long-term investment -- because it's the antithesis of trading -- and it would probably eliminate the conflict of interest that is obvious if your fiduciary has two sets of fiduciary duties.

One is the fiduciary duty to the mutual funds, and the other is the fiduciary duty to the shareholders of his publicly held company or publicly held conglomerate. Those two fiduciary duties are in direct conflict and so we, of course, quote the Bible: "No man can serve two masters," and then we add to that what Matthew quoted the Lord as saying right after that: "For he will hate the one and love the other."

Now in this business, who pays the portfolio managers? Who makes all the money? Who has all the public stock? The manager gets all the love. I won't say they hate the shareholders -- I wouldn't say that at all -- but they love the managers more.

Gardner: I want to just talk in the end a little bit about the fact that you've been a business leader. We talk about investments, but you started a company and ran that business, and it has $2 trillion in assets today and 14,000 employees. It's massive. I'm sure it's way beyond what you would have dreamed of in 1974 -- although I'm sure you were optimistic about your chances, given the solution you created.

How do you evaluate talent -- the people that you work with? What were some of the cultural features of Vanguard during your leadership?

Bogle: One of them is exemplified by a story I tell about the time we got to around 200 employees. I thought, "We really ought to have a personnel department" -- human resources, it's called now -- it seemed like a good idea.

I was really a dictator, so I looked around and tried to see who was not busy in the office; we were very strapped for being able to spend any money. There was a secretary in the legal department, a very lovely woman. I talked to our lawyer. We had one lawyer then -- we have 140 now -- that's called progress!

I said, "Could I use her to run a little personnel effort -- interview people and things?"

He said, "Yeah, I think she can do that."

So, she comes into my office. "I'd like you to do this."

"Whatever you want, Mr. Bogle."

We talked a little bit, and she started to go out of the office. She was about to walk out the door and she turned around, came back in and she said, "I want to do whatever you want me to do, Mr. Bogle, but I don't know what it is you want me to do."

I said, "Well, I'm not sure I know either." This is what happens when you're a very small company. I had a lot of things on my mind, of course, and I said, "I don't know what it is that I want you to do, but let's start with this. Hire nice people and then make sure that they hire nice people. And that's the best I can do on this."

Most of the jobs at Vanguard -- some of the technology jobs require a whole lot of professional skill. Most jobs can be done by intelligent human beings with a little experience and the motivation to do them.

I look at Vanguard as not being some, "Can we hire the best and the brightest?" I'd say -- it's a big universe -- we probably have our share of them. But you try and get people that you can work with, that can work well with others. They're going to try and not make the same mistakes you did.

The change from a tiny, embryonic organization, where there is a captain and the rest of the oarsmen down below in the galley -- that's obviously oversimplified -- but our mission is very simple. Our presentation is very simple.

When you think of what we can explain to people, and what they should do in investing, it's right out of the proverbial hornbook, the ABCs of the old days. It works, it's understandable, and it's guaranteed to give you your fair share of whatever returns the stock and bond markets are generous enough to give us -- or mean enough to take away from us.

Gardner: There's a Gallup survey that shows that seven out of 10 people going to work in America today basically say they're indifferent or even downright negative about the organization they're working for.

In a funny way, in that rowboat scenario, where we're all rowing together ... in many organizations, more than half of the people don't even really care about what they're doing. Obviously you've found people who are passionate about the principles.

Bogle: We have more turnover than I would like, but that happens at these middle-grade job levels. Our people are well paid. They've got terrific benefits with partnership plans. They share in the earnings we generate for shareholders.

I still spend an hour with each Award for Excellence winner -- the program I put in there all those years ago -- and there are probably about eight per quarter, so I get to sit down and talk to eight people a quarter. It may not sound like much in an organization that big; 32 a year, 320 in 10 years, 640 in 20 years.

Now these are exceptional people. That's why they got the Award for Excellence, so I'm not kidding myself. But we have human conversations; talk about commitment, talk about opportunity, talk about the lack of opportunity. Talk about anything they want to talk about. They're among the most engaging and pleasant moments of my career.

Gardner: You're in the unique position of having started the company, run the company, and now sit as an observer of your creation. Succession is such a big issue for so many. We have a lot of small-business owners that are at The Motley Fool and thinking about that. What have you learned, or what do you think about?

I find it to be a great thing that you have minor "lovers' quarrels" with things that are happening at the company that you created -- which I think must be intellectually stimulating for you, and the organization. How is that experience for you?

Bogle: It's difficult. Let me be honest about it; it's difficult. The company is not particularly smitten with my directness and outspokenness, and my books.

People don't like criticism, generally speaking, but I'm just trying to tell it the way I see it. I'd say my book, The Clash of the Cultures, almost entirely reads like a great big commercial for Vanguard. There's some things they don't like in there -- talking about the Wellington Fund fee increase, which I believe was unjustified, talking about our proxy voting policies, talking about the possibility of having a transaction tax -- and a bunch of other things that are similar to that.

I finally had to develop a response, when someone says, "I understand you disagree with Vanguard on that point."

I say, "Absolutely not. I would never disagree with Vanguard. Vanguard disagrees with me, and it's their right."

Gardner: You're optimistic about what Vanguard will become over the next 100 years.

Bogle: Where you are, you have to be optimistic.

There are risks out there. Will they ever try and "de-mutualize" the company? That's happened in a lot of places. I don't think it can happen there, but anything can happen in this world when you've got human beings involved.

I think it's important, even as we maintain the letter, or the implementation of a mutual structure, we have to maintain the spirit of that mutual structure too, and that requires some doing.

You've got to keep your mind on the mission; that your mission is to serve, day after day after day.

It's very difficult to see anything that can get in the way of that, except some massive thing like a huge stock market collapse; that would not be good for us. Every once in a while, we depart with some of these new funds. I have a little question mark about, "You must be betting they're better than an index fund." I wouldn't even look. I just say, "I bet they're not," because nothing can be in the long run.

I watch. I think people at Vanguard really -- I don't want to overdo this -- but I think they love me. I'm a normal human being ... more or less normal anyway! I'm straightforward. They can identify with that. Even the people that have been there for a very short period of time seem to know who I am.

Gardner: It's total authenticity, which means sometimes we'll agree, sometimes we won't agree.

Bogle: Yes.

Gardner: A member of ours named Vicki was bringing up the importance of skin in the game. You've had skin in the game with the business, and have your capital with the Vanguard funds to this day.

The mix of those qualities -- even though it may lead to some public disagreement -- is overall a benefit to both the organization, to you, and to the outcome for the customers of that.

Bogle: I really don't care who benefits or who doesn't benefit. I have to tell it as I see it. I've been able to do that for a long, long time.

I was key to Vanguard going into business. You walk a road that you think is the right road. You walk it as straight as you can. You be as honest as you can.

I've gotten so I find confessing my mistakes, of which the number in my career -- I don't even want to get into hundreds, thousands ... I don't know how many I've made; an infinite number, maybe, in my career -- it's kind of liberating to say, "I really blew that one."

I blew a lot of stuff. But the underlying thesis, if you will -- the underlying concept, the underlying idea of owning a market, whatever the market may be, and getting your fair share -- has worked and will work. Who else can say that about what's going on in their own company?

Gardner: Small failures all the way to great success.

My final question: How are you spending your time now? An incredible part of your story -- which we haven't talked about here but we've talked about on the radio -- is your human heart. How old is your heart right now?

Bogle: Well, I got my heart when it was 26 and I've had it for almost 18 years.

Gardner: A year younger than I am.

Bogle: Forty-two. But I'm starting to feel a little more like 84. The trail in recent years has been a little difficult -- the physical trail. I've had some very profoundly serious problems and long hospitalizations, but you go into them optimistically. My wife is a powerful support, and my kids are wonderful. You get over the bumps. You're always optimistic.

The idea when you go into a hospital again is they put you down on the gurney and you just go, "Here we go again." Like the whole business with the transplant, my reaction is just the same, Tom.

If I thought jumping up and down on the kitchen table and screaming and yelling about the unfairness of life would help my condition, I would do it! But it occurs to me it would make it even worse. So you kind of go along. You speak out with honesty. I'm not trying to say something to hurt somebody, but I'm not going to agree with something I don't agree with. I think Vanguard benefits from that immensely.

The shareholders; I'm still close to a lot of them. I still get a lot of correspondence. I'm still writing a lot. I have an article about to come out in The Journal of Portfolio Management, another article about to come out in the Financial Analysts Journal, a foreword to a book about Paul Cabot, one of the founders of the industry, and a book about John Maynard Keynes published by, I think, Oxford University Press, in which I write the final chapter called, "Adam Smith and Capitalism." And I did a foreword for John Wasik's book on John Maynard Keynes as an investor.

So, I've got Keynes. I've got Adam Smith. I've got one of the industry's founders, and I've got two academic articles, and I'm starting to worry that I'm going to run out of things to do.

Gardner: I don't think that's possible, Jack! Any time you need any extra work that you'd want to do, just come hang out with Fools.

Bogle: OK. Well, you've been a good Fool, Tom.

Gardner: Well, it all started with "Bogle's Folly ..."

Bogle: We're associated.

Gardner: We're bound by name. Jack Bogle, thank you so much for taking time. We could continue this conversation for another hour, but let's let you get on with your day.

Bogle: But we tire.

Gardner: Thanks, Jack.

Bogle: Thanks, Tom, very much.


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