John Bogle, founder and former chair of the Vanguard Group and father of the index fund (which we have long recommended for most investors), is concerned. And that's putting the matter mildly. Much like The Motley Fool, Bogle has long criticized the many ways that Wall Street fails individual investors, often focusing on his area of particular expertise: mutual funds. (Check out his book Common Sense on Mutual Funds.)
He's got a new book out now, and its focus is broader. Consider just the title: The Battle for the Soul of Capitalism.
In corporate America
Back in October, when he received the 2005 Outstanding Financial Executive Award from Financial Management Associates International (FMA), Bogle gave a speech outlining many of his concerns.
He began by pointing to the "staggering increase in managers' compensation, with the pay of the five highest-paid executives of public companies more than doubling, from 4.8% of profits in the early 1990s to 10.3% recently, a period in which earnings themselves -- the measure our CEOs love to brag about -- grew at a puny 1.9% annual rate." Wow -- imagine 10% of potential earnings going to executive compensation!
This made me want to catch up on the nation's top-compensated CEOs. I dug up an April 2005 list from Forbes, which offered the following total compensations for the past year:
- Terry Semel, Yahoo!
(NASDAQ:YHOO), $231 million
- Barry Diller, IAC/InterActiveCorp,
(NASDAQ:IACI), $156 million
- William McGuire, UnitedHealthGroup
(NYSE:UNH), $125 million
- Howard Solomon, Forest Labs
(NYSE:FRX), $92 million
- George David, United Technologies
(NYSE:UTX), $89 million
- Lew Frankfort, Coach
(NYSE:COH), $86 million
- Edwin Crawford, Caremark Rx, $78 million
- Ray Irani, Occidental Petroleum, $64 million
- Angelo Mozilo, Countrywide Financial, $57 million
- Richard Fairbank, Capital One Financial
(NYSE:COF), $57 million
Lists like these can easily make those of us who make far less than $1 million -- or even $100,000 -- see red. It's particularly egregious when the highly paid executives don't deliver, as is often the case. But sometimes there's an argument to be made for a lavish paycheck -- if it accompanies lavish results. Coach, for example, sports a five-year annualized total return of 65%, per a January 2006 Forbes article. Occidental Petroleum earned 32%, Caremark Rx earned 37%, UnitedHealth earned 33%, and Yahoo! earned 17%. Still, as someone earning less than $100,000, I have trouble seeing how these compensation levels don't embarrass those who give and receive them.
Bogle's next target: "The rise of financial engineering -- call it 'manipulation' -- in which earnings are managed to meet the 'guidance' that these executives give to Wall Street, quarter by quarter. One of the prize tools: raising the assumptions for future returns on corporate pension plans even as prospective returns eroded. Just think of it: In 1981, when the long-term U.S. Treasury bond yielded 13.9%, the projective plan return was 7%. Currently, with bond yields at 4.7%, the projected return averages about 8.5%. It's not going to happen, and pension plan inadequacy will be our next financial scandal."
We've tackled this topic many times -- read Rich Smith's "Your Incredible Vanishing Pension." If you're worried about your financial readiness for retirement, read some of our many articles by Robert Brokamp. Better yet, give his excellent Rule Your Retirement newsletter a try (for free), and see why thousands of subscribers are smiling.
Let's move on to the investment world. I've noted statistics showing increasing stock ownership among Americans, generally via mutual funds, over the past decade. That's always seemed like a good thing, but Bogle pointed out a dark tangent:
"As our ownership society of direct holdings of stocks by individual investors nearly vanished -- they held 92% of all stocks in 1950 but hold only 32% today -- corporate control fell into the hands of giant financial institutions -- largely pension funds and mutual funds -- whose share rose commensurably, from 8% to 68%. But these agents, beset by conflicts of interest and their own agendas, failed to represent their principals."
He went on to explain that the average institutional investor holds a stock for an average of just one year, versus six years during Bogle's early days. Institutions just aren't as interested in overseeing their holdings. "Owners must give a damn about the rights and responsibilities of corporate governance. Renters could hardly care less," he said.
In mutual fund
Then Bogle moves to mutual funds. "Over the past two decades, the return of the average equity fund has lagged the return of the S&P 500 Index by about 3 percentage points per year -- 10% versus 13% -- largely because of costs. But largely because of poor timing and poor fund selection, the average fund investor has lagged by another 3 percentage points. Result: In this grand era for investing, the average investor has captured but 27% of the market's compounded return." Ouch.
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Here are some thought-provoking final words from Bogle: "When I entered this field all those years ago, virtually 100% of mutual-fund management companies were relatively small, professionally managed, privately held firms. Since then, they have experienced their own pathological mutation. Today, 41 of the 50 largest firms are publicly held, including 35 that are owned by giant U.S. and global financial conglomerates. To state the obvious, these conglomerates are in business to earn a return on their capital, not a return on your (the fund investor's) capital. Remember: The more the managers take, the less the investors make."
UnitedHealth is a Motley Fool Stock Advisor pick.
Selena Maranjian 's favorite discussion boards include Book Club , Eclectic Library, and Card & Board Games. She owns shares of IAC/InterActiveCorp. For more about Selena, viewher bio and her profile. You might also be interested in these books she has written or co-written:The Motley Fool Money GuideandThe Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools.