Jack Bogle: "Liquidity Is the Last Refuge of the Scoundrel"

John C. Bogle is the founder and retired CEO of The Vanguard Group, the largest mutual-fund organization in the world, with more than 160 mutual funds and 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.

While the Fool believes in long-term investing and holding periods measured in years, today's market sees turnover ratios of 100% or more in an actively managed fund. In this video segment, Bogle agrees that some turnover is necessary but that a combination of ego and marketing has taken things too far.

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Tom Gardner: 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%.

Jack 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.


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