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How Much Should You Pay for Financial Advice?

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.

An individual investor only needs to hold a few funds -- so why does Vanguard have so many? In this video segment Bogle explains, and then takes a look at the "rent-seeking" financial services industry, and how the costs add up.

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Tom 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?

Jack 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.


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