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March
7 , 2001: While many alumni owe much to a Princeton education, few can trace their careers more directly to it than John C. Bogle '51. Bogle, who founded the mutual-fund company Vanguard Group in 1974, has almost single-handedly transformed the way millions of Americans invest their money. He has relentlessly preached the virtues of keeping the costs of investing down, when most mutual-fund purveyors would prefer that their customers ignore fees, commissions, and other expenses entirely. To assure that Vanguard's interests were aligned with those of its customers, he made the customers owners of the company. In 1976 he started the first index fund that ordinary investors could buy. Since then the Vanguard 500 Index Fund has become the largest mutual fund in the world, with $100 billion in assets, and Vanguard has started more than 30 additional funds that track other market indexes. It all began with Jack Bogle's senior thesis, which earned him a 1+ (as A+ was called in the '50s). In the following address, given to young alumni at the Princeton Club of New York on February 16, Bogle, the first businessman ever to win the Woodrow Wilson Award exemplifying "Princeton in the nation's service," tells how his college experience launched him on a remarkable career. He also shares his thoughts on today's investment climate.
Let me get right to the point: Were there no Princeton, there would be no Vanguard. For it was only a wonderful series of happy accidents - beginning with my admission to this best old place of all as a member of the great Class of 1951 - that led to the creation of Vanguard. Today we manage some $560 billion of investor assets, the second largest mutual fund complex in the world. That fact, in as of itself, is not important. What is important is that we've developed a unique corporate structure, a more efficient and economical way to serve investors and a new way of managing investments that have together begun to reshape the way the financial community thinks about investing. There's not much question that the first of the almost infinite number of breaks I've been given during my long life (a word about that later on!) came when, with a scholarship and a job at Blair Academy, I received a splendid college preparatory education. That priceless advantage, in turn, presented me with another break. With the help of another full scholarship and a job waiting on tables in Commons, I entered Princeton University. Despite my academic success at Blair, I found the early going at Princeton tough. The low point came in the autumn of 1948, when I struggled with the first edition of Paul Samuelson's Economics: An Introductory Analysis. It was not a happy introduction to my major field of study, and I earned a well-deserved 4+ (D+ today) as my mid-term grade. With my other grades scarcely more worthy, my scholarship - and hence my Princeton career, for I had not a sou of financial support - was in dire jeopardy. But I ended the term with a hardly distinguished 3 (today a C) average. A year later, academic distinction still eluded me, but fate smiled down on me once again. Determined to write my senior thesis on a subject which no previous thesis had ever tackled, Adam Smith, Karl Marx, and John Maynard Keynes were hardly on my list. But what topic should I choose? In December 1949, perusing Fortune magazine in the reading room of the then-brand-new Firestone library, I paused on page 116 and read an article about a business which I had never even imagined. And when "Big Money in Boston" described the mutual fund industry as "tiny but contentious," this determined young kid decided that mutual funds should be the topic of his thesis. I entitled it, "The Economic Role of the Investment Company," and, as the saying goes, the rest is history. I can't tell you that my thesis laid out the design for what Vanguard would become. But many of the values I identified then would, 50 years later, prove to lie at the very core of our success. "The principal function of mutual funds is the management of their investment portfolios. Everything else is incidental . . . Future industry growth can be maximized by a reduction of sales loads and management fees . . . Mutual funds can make no claim to superiority over the market averages." And, with a final rhetorical flourish, funds should operate "in the most efficient, honest, and economical way possible." An early design for a sound enterprise? Or callow, even sophomoric, idealism? I'll leave it to you to decide. But whatever was truly in my mind all those years ago, the thesis clearly put forth the proposition that mutual fund shareholders ought to be given a fair shake. In any event, the countless hours I spent researching and analyzing the industry in my carrel at Firestone was rewarded with a 1+, and led to a magna cum laude diploma - a delightful, if totally unexpected, finale for my academic career at Princeton. And it came with a fine sequel: A half-century later, Dr. Samuelson, by then a Nobel Laureate in Economics, would write the foreword to my first book! Fate smiled on me yet again when a great Princetonian named Walter L. Morgan, Class of 1920 and the founder of Wellington Fund, read my thesis. In his own words: "Largely as a result of his thesis, we have added Mr. Bogle to our Wellington organization." While I agonized over the risks of going into that "tiny but contentious" business, my thesis had persuaded me that the industry's future would be bright. So I cast my lot with this great man, my good friend until his death at age 100 in 1998, and never looked back. He had given me the opportunity of a lifetime. Bless his soul! By 1965, Mr. Morgan had made it clear that I would be his successor. At that time, the Company was lagging its peers, and he told me to do whatever it took to solve our problems. Young and headstrong (I was then but 36 years of age), I put together a merger with a high flying group of four "whiz kids" who had achieved an extraordinary record of investment performance over the preceding six years. (Such an approach - believing that past fund performance has the power to predict future performance - is, of course, antithetical to everything I believe today.) Together, we five whiz kids whizzed high for a few years. And then we whizzed low. The speculative fever in the stock market during the "Go-Go Era" of the mid-1960s died, and was followed by a 50% market decline in the early 1970s. The once happy band of partners had a falling out, and in January 1974 I was fired from what I had considered my company. In the Business and Out But without both the 1951 hiring, which providentially brought me into this industry, and the 1974 firing, which abruptly took me out of it, there would be no Vanguard today. Removed from my position as head of Wellington Management Company, I decided to pursue an unprecedented course of action. The Company directors who fired me comprised a minority of the board of Wellington Fund itself, so I went to the Fund Board with a novel proposal: Have the Fund, and its then-ten associated funds (today there are 100), declare their independence from their manager. It wasn't exactly the Colonies telling King George III to get lost, as it were, in 1776. But fund independence - the right of a fund to operate in the interest of its own shareholders, free of conflict and domination by the fund's outside manager - was at the heart of my proposal. Mirabile dictu! After a contentious debate lasting seven months, we won the battle to administer the funds on a truly mutual basis, under which they would be operated, at cost, by a wholly owned subsidiary. With only weeks to go before our incorporation, we still had no name for the new firm. Fate, of course, smiled again. In September, 1974 a dealer in antique prints came by my office with some small engravings from the Napoleonic War era, illustrating the military battles of the Duke of Wellington, for whom Mr. Morgan had named his first mutual fund 45 years earlier. When I bought them, he offered me some companion prints of the British naval battles of the same era. Ever enticed by the sea and its timeless mystery, I bought them, too. Delighted, the dealer gave me the book from which they had been removed. Even as I had browsed through Fortune in 1949, I browsed through the text. With my usual luck, I turned to the saga of the historic Battle of the Nile - recently designated by The New York Times as the greatest naval battle of the past millennium - where Lord Nelson sank the French fleet, ending Napoleon's dreams of world conquest. I paused, and noticed Nelson's triumphant dispatch from his flagship, "Vanguard, off the mouth of the Nile." Together, the Wellington tie-in, the naval tradition embodied in HMS Vanguard, and the leading-edge implication of vanguard, were more than I could resist. And on September 24, 1974, The Vanguard Group was born. Consider this: No Princeton, no thesis; no thesis, no Morgan; no Morgan, no Wellington; no Wellington, no merger; no merger, no firing; no firing, no Vanguard. Without Princeton the patriarch, Vanguard the child would never have been born. The Character of Vanguard Even a casual reading of my ancient thesis would, I think, reflect its pervasive idealism. To this day, I use quotations from it to define the genesis of my views, from the forces that move financial markets to the forces that fail to move fund managers to become responsible corporate citizens. But the highest manifestation of this idealism comes in my long standing view that the central principle of the business of managing mutual funds should be, not the marketing of financial products to customers, but the stewardship of investment services for clients. Holding the interests of our clients as our finest value brings me to Vanguard's central mission: To provide to investors not only the highest quality services, but also the lowest possible costs. Our drive to become the low-cost provider of financial services in the world has been realized largely by breaking new ground in the industry: Having the mutual funds themselves responsible for their own governance and administration. Not only would we operate the funds at cost, but we would operate them at the lowest possible cost, disciplined and sparing in every expenditure, always asking ourselves: "Is this expenditure necessary?" Put another way: "If this were my own money, would I spend it?" (Happily for our investors, I hate to spend my own money!) All of this is important only if costs matter. They do. Costs matter. I repeat this phrase so often in my speeches that a Cleveland journalist compared me with Cato, the Roman orator whose speeches in the Forum always ended with a call for the defeat of Carthage: "Carthago delanda est." Why do costs matter? Consider the analogy of the casino, in which the investor-gamblers swap stocks with one another, a casino in which, inevitably, all investors as a group share the stock market's returns, no more, no less. But only until the rakes of the croupiers descend. Then, what was a fruitless search by investors to beat the market before costs - a zero-sum game - becomes a negative-sum game after the costs of investing are deducted - a loser's game. Playing the mutual fund game carries heavy costs and entails lots of croupiers, each wielding a wide rake. Sales commissions when most funds are purchased. Fund management fees and operating costs. Marketing costs - all those expensive television advertisements you see. The opportunity cost of having funds hold cash in rising markets. Transaction costs paid to stock brokers and investment bankers when fund managers buy and sell the stocks in fund portfolios. The excessive tax costs to which funds unnecessarily subject their shareholders as the result of their incessant, often mindless, turnover. Simply put, these costs, compounded year after year, combine to give mutual fund investors but about one-half of the market's return in the past decade and - I'm glad you're sitting down! - only one-third in the past quarter century. The investor, who put up 100% of the capital and assumed 100% of the risk, garnered just 33% of the market's return. Yes, costs matter. The First Index Fund It was the conviction that costs are crucial that quickly led Vanguard to the first of the major mutual fund innovations with which I've been identified, our pioneering formation of the first market index mutual fund. In mid-1975, only a few short months after we began operations, I began to lay the groundwork for the fund. I can't honestly say that I was thinking about it a quarter century earlier, when I was writing my Princeton senior thesis (remember, "mutual funds can make no claim to superiority over the market averages"). The magic, such as it may be, of the index fund is simply that it gets the croupiers largely out of the game: No sales charges; no management fees; tiny operating costs; virtually no transaction costs; high tax efficiency. Anyone could have had - and I imagine many others did have - this banally simple, completely obvious insight. But, as fate would have it, a firm had just been formed that - like the suspect in a good murder mystery - had not only the opportunity, but the motive, to seize the day and take this first step that is now beginning to re-shape the way we think about investing. After recognizing our opportunity, only force of will - persistence, patience, and determination, along with a healthy dollop of missionary zeal - was required. Implementation, after all, has always been far tougher than ideation! But indexing worked in practice, and it slowly caught on. The heresy of 1975 has become the dogma of 2000. Today, our stock and bond index funds, along with a variety of other Vanguard funds offering both index-like strategies and index-like costs now account for upwards of 70% of our huge asset base, and have driven our growth during the past decade. The New Market Environment During the Nineties, the U.S. stock market provided by far the highest returns in history, averaging 17% annually. The soaring market, along with the surge in stock holdings of American families that accompanied it, was a powerful force in driving Vanguard's growth. But that environment vanished last year. The stock market - that once smoothly-paved road to easy riches - became a bumpy road to capital erosion. The burst in the NASDAQ bubble resulted in a 50% drop in value, while NYSE issues were down less than 5%. In all, from its high on March 24 to its recent low, the U.S. stock market has tumbled almost 25%, erasing $3 trillion of market value, and one of the three most severe tumbles in the last 60 years (although this one may not yet be over). Nonetheless, I look at the recent drop as a blessing in disguise, indeed, three blessings: First and most important, the bear market has helped to bring back into focus financial reality about investment returns and risks. No, the 17% average annual return during the Nineties never was a new norm. Yes, a New Era in which common stocks no longer carried a heavy risk of capital loss was a delusion. Second, for investors accumulating stocks over long-term time horizons, lower prices are good, just as are lower prices for computers or food. You can buy more for less. If you will not retire for many years, it's better to accumulate stocks with the Dow below 10,000 rather than above 20,000. Third, the bear market is beginning to make stocks attractive once again. Why? Simply because lower stock prices, combined with high corporate earning, mean that stocks, selling at 30 times earning a year ago, are now selling at 24 times. Thus, valuations - if hardly cheap - are considerately more attractive. In short, the ice-cold shower that has hit the stock market, however unpleasant, however unexpected, however devastating to the personal wealth of very aggressive investors, has sent a valuable and essential message to us all, a lesson that has brought the hard realities of investing into a financial world so recently overwhelmed by an unsustainable aura of tinsel and glitter: The Mathematics of the Markets Is Eternal. I believe we are now in a New Environment - not to be confused with the so-called "New Economy" - an environment in which future investment returns will be lower, risk awareness higher, and investor expectations more muted. So let me now speculate about what future market returns might be. To state what must be obvious, when investor expectations reach their pinnacle, stocks are priced to those expectations. As a result, stocks become valued at levels that have nowhere to go but down. Simply put, investors do better when they buy stocks at low price/earnings levels and worse when they buy stocks at high price/earnings levels. (Not every time, but most of the time.) With the sharp decline since last spring, the price/earnings ratio has tumbled from the 30 P/E when 2000 began to 24 times today. Stocks are clearly cheaper, though the P/E ratio is still 50% above its long-term norm of 16 times. What lies ahead for the stock market? I believe the best way to peer into the uncertain future is to consider the two separate and distinct numbers - one for investment return; one for speculative return - that constitute the total market return. Investment return is simply the total of the current dividend yield on stocks (today it's only about 1%) and the earnings growth expected for, say, the next decade. Long-run annual earnings growth has been 6%, but I'll assume, optimistically, an 8% growth rate. So, that growth rate would bring the total investment return to 9%. Speculative return - a far more volatile figure - measures the impact of any change in the price/earnings ratio. It can add to - or subtract from - investment return. If it remains the same, the investment return will exactly equal the market return. If, over the coming decade, today's ratio were to rise by, say, 33% to 32 times, we would add an annual 3% of speculative return to the 9% investment return. Market return: 12%. But if the ratio falls 33% to 16 times, subtract 4% annually. (Yes, 3% more, but 4% less. Reverse compounding is significantly more negative.) Market return: 5%. While forecasting speculative return is, well, speculation, pure and simple, I believe that the price/earnings ratio a decade hence is considerably more likely to be lower rather than higher than today's. If so, total stock market returns might run in the range of 5% to 7% in the coming decade. In such a New Environment, Vanguard's growth will doubtless slow. But I believe our share of market will grow even more rapidly. And I believe that the strength of our essentially conservative investment principles, the power of our low costs (even more important in an era of modest returns), and the special attractiveness of our bond and money market funds in an environment in which those asset classes will provide more competitive returns with stock returns will make us the envy of our competitors. Whatever the case, we'll all be living in interesting times. Economics and Idealism In retrospect, I believe that idealism - the dream of a better world; fairness to one's fellow human beings; focus on simplicity; emphasis on stewardship - has driven my life from Blair Academy to Princeton, and then through my long career. Happily, I've learned that the link between idealism and economics is a powerful one. Indeed, both Vanguard's structure and the index fund concept are classic examples of the fact that enlightened idealism is sound economics. This link between idealism and economics is hardly limited to Vanguard. Indeed, the idealism of that great Princetonian Woodrow Wilson was reflected in his economic philosophy. In his first inaugural address as President of the United States in 1912, Wilson presented a sweeping plan for financial reform which culminated in the Federal Reserve system; which slashed tariffs and opened America to global competition; and which toughened the anti-trust laws in order to have free enterprise prevail. His passion for his goals was hardly hidden. Listen to his words: "To restore that ancient time when America lay in every hamlet, when America was seen in every fair valley, when America displayed her great forces on the wide prairies, ran her fine fires of enterprise up over the mountainside and down into the bowels of the earth, and eager men everywhere captains of industry, not employees . . . America stands for opportunity. America stands for a free field and no favor. America stands for a government responsive to the interests of all." Could it be better said today? I'm happy to report that the half-century chronicle that links Princeton and Vanguard continues. Last September, McGraw-Hill Corporation published John Bogle on Investing: The First 50 Years, the initial volume of its "Great Ideas in Finance" series It includes 25 speeches I've given over the years, as well as my ancient Princeton senior thesis, published at last, a half-century after it was written - yet one more piece of good fortune in the seemingly endless string of breaks that I've recounted this evening. The icing on the cake: a Foreword by legendary Princetonian and former Federal Reserve Chairman Paul Volcker, Class of 1949.
Returning Full Circle Thanks to an enterprising Vanguard crew member, I received not so long ago a mint-condition copy of the December 1949 issue of Fortune that contained the mutual fund article that inspired my thesis. I re-read it: Clearly, "tiny but contentious" had now become "big and contentious." And yet another coincidence: The feature essay was entitled "The Moral History of U.S. Business." I re-read that long-forgotten article too. The essay, I quickly realized, described the kind of moral responsibility in business that echoes Vanguard's guiding principles. And it cites the eerily apt words of William Parsons, "a merchant of probity," who in 1844 described the good merchant as "an enterprising man willing to run some risks, yet not willing to risk in hazardous enterprises the property of others entrusted to his keeping, careful to indulge no extravagance and to be simple in his manner and unostentatious in his habits, not merely a merchant, but a man, with a mind to improve, a heart to cultivate, a character to form." As for the mind, I still strive every day - I really do! - to improve my own. As for the heart, no one - no one! - could possibly revel in the opportunity to cultivate it more than I. A month from now, after all, I'll celebrate the fifth anniversary of the amazing grace represented by my incredibly successful heart transplant - a piece of luck that, among other things, makes it possible for me to be with you tonight. And as for character, I've tried not only to live my life, but build my business with integrity above all - in every aspect of how we manage the billions of dollars entrusted to our stewardship. I pray that my company will forever hold that standard high, and continue to put the will and the world of a business enterprise in the service of others - in the Nation's service. And I hope each of you young Princetonians here this evening will also do your best to consider your career, not just as a livelihood, but as a calling as well, a calling to serve others. Perhaps you will be as inspired as I am by Woodrow Wilson's words in his inaugural speech as President of the University in 1902, demanding that the Princeton graduate "derive his knowledge from the thoughts of the generations that have gone before him." He noted that, "the ages of strong and definite moral impulse have been the ages of achievement. University men ought to . . . serve a free nation whose progress, whose power, whose prosperity, whose happiness, whose integrity depend on individual initiative and sound sense. "It is," he said, "the free capital of the mind the world most stands in need of, spiritual as well as material, which help all men to a better life . . . No task rightly done is truly private. It is part of the world's work." The infinite number of blessings that have been fortuitously showered on me by my Princeton education have encouraged me to strive to reach the lofty goals cited by Woodrow Wilson, even as I realize they are beyond my grasp. In this new century, so laden with challenge and opportunity alike, I hope you too will be similarly blessed. If you are, I hope too that you will do your best to make the most of your blessings and, 50 years hence, emerge late in your careers and lives with your own ideals as undiminished by time and tide, by triumph and tragedy, by joy and sorrow, as my own.
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