John Bogle on Capital Allocation

In fact, the correlation between the initial yield and subsequent ten-year return of bonds is a healthy 0.91. Not bad, once we realize that perfect correlation is 1.00. The reason for this close correlation is not complicated: If interest rates remain unchanged, of course the returns would be identical. But while rising rates would depress bond prices, the higher reinvestment rate on each year’s interest payment would have a countervailing impact. And vice versa. In mid-1982, the yield on bonds—the Lehman Aggregate Bond Index of U.S. Government and investment-grade corporate bonds—was 14%; during the subsequent decade the annual return on bonds came to 13%, and to 10% over the past two decades. Today, with the bond yield at just over 6%, bond returns in the coming decade should run between, say, 5% and 7%. What we know—or at least can be highly confident about—is that we are looking at future bond returns that are also a pale imitation of those we have enjoyed in recent decades.

But that’s the way I’ve always wanted to play the game. While it has seldom been noted by industry observers, our growth has been importantly fostered by what is measurably the highest level of client loyalty in the mutual fund industry. Vanguard shareholders have consistently redeemed their shares at only about one-half the industry rate—about 10% of assets per year, versus almost 20% for the other fund complexes (Chart 4). Investors who purchase a Vanguard fund stay at Vanguard for an average of 10 years, compared to just five years for those who invest with our peers. Consider this example of what this has meant to our growth: This year our share redemptions will be about $55 billion dollars. With new share purchases of $105 billion, our net cash flow will be about $50 billion (before dividend reinvestment). Had our shares been redeemed at the industry rate—i.e., doubling to $110 billion—we would have actually experienced a cash outflow. Repeated year after year, then, an industry redemption rate for Vanguard would have radically vitiated our market share gain. Client loyalty, in short, is one of Vanguard’s major assets. Low Costs Produce High Performance The attraction Vanguard obviously holds for long-term investors has been driven by two main factors. First are our hallmark low-costs. In an industry where costs have soared over the years, Vanguard is distinguished by driving its costs ever lower, even as the industry’s costs have soared.(Bear

counsel for the fund’s underwriters reported that he had purchased 1000 shares at the original offering price of $15.00 per share—a $15,000 investment. The value of his holding that evening (including dividend reinvestment), he proudly announced, was $461,771. Now there’s a number that requires no comment. (Well, maybe one comment. Of the 360 equity mutual funds then in existence, only 211 remain today.) I hope that my bluntness today about the merits of classic all-market index funds has not pushed you beyond your tolerance. But if you aren’t persuaded by what such index funds have accomplished during their 30-year history, at least reflect on the underlying reasons for their success; no more than common sense, simplicity, and the relentless rules of humble arithmetic, broad diversification, low expense ratios, no sales loads (and no aggressive marketing), and minimal portfolio turnover, held by investors for the long-term and guaranteed to give them their full share of whatever returns the financial markets are generous enough to provide.

Under the SOP, it was deemed “materially misleading” to, among other things, combine into a single figure dividends for investment income and distributions from any other source; to present charts showing results of initial investments which include dividend reinvestments; to present charts or tables which do not provide adequate and accurate disclosure of material facts; to make extravagant claims regarding management ability or competency; or to compare a fund’s record with any other fund or market index without pointing out the material differences or similarities between the subjects of the comparison. The SOP, however, proved unduly restrictive, prohibiting, for example, the publication of a fund’s total annual return. (Ironically, total return has become the universal metric for today’s industry.) It also required levels of detail that obscured the clear presentation of returns that included dividend reinvestment. Nonetheless, if we are to protect investors without burdensome regulation, we must educate them in the sunlight of full disclosure. Exactly how to do this, I do not know, for it involves shareholder reports, sales literature, and prospectuses, each of which operates in a different regulatory framework. But if there is a will, I’m sure there’ll be a way. But don’t count on any support from the mutual fund industry nor the brokerage industry, nor likely from most financial advisers.

Economic Markets and Public Purpose (With Some Reflections by Adam Smith) A Lecture by John C. Bogle Founder and Former Chairman, The Vanguard Group Before The Reinvestment Fund’s 24th Annual Celebration Philadelphia, PA June 11, 2009 It seems almost fated that I’d come to address you during these days of crisis in our economy and travail in our financial markets, for we have much in common. Both the Reinvestment Fund and The Vanguard Group—the firm that I created almost 35 years ago—are financial service organizations that were created to march to a different drummer, organizations that have done their best to set a new standard—to “rediscover a public purpose,” using a phrase from the title of the recent monograph authored by your Jeremy Nowak and Ellen Seidman—in our investment sector, putting service to the community (in your case) and service to investors (in our case) before service to self. The sad fact is that it is in the field of finance where the seeds of our economic crisis and market travail were sown. The financial sector is easily enough seen as a monolith, driven by opportunism rather than service, by marketing rather than management, by self-interest rather than community good, by complexity rather than simplicity, by short-term speculation rather than long-term investment, and by salesmanship rather than stewardship. Vanguard is among the few—the very few—exceptions to this profile, so it is only appropriate that we meet together today, in common cause.

I applaud The Reinvestment Fund (TRF), and the worthiness of your cause of community development. Through place-based revitalization focused on targeted financial investments, real estate development, and social service, you bring hope to those in the lower reaches of the nation’s economic mainstream. In doing so, according to the standards cited in another Nowak essay, you demand of yourselves: (1) efficiency; (2) minimum intrusiveness into the community; (3) a market-building horizon; and (4) the most direct route to the intended outcome. You also recognize that, since the capital that you put to work does not receive a conventional return on investment, you depend on public subsidy and private philanthropy, all in the name of community development. With the exception of that final point, there are remarkable similarities between TRF and Vanguard. We too have sought a better way to invest the hard-earned dollars of those human beings who have entrusted their savings to our care. I’ve challenged the financial system and done my best to improve it—to build a better world for investors. Vanguard was built on a firm foundation of service to our shareholder-owners rather than service to ourselves, in a unique mutual mutual fund structure in which our fund shareholders actually own the funds’ management company.

Warren Buffett, his partner Charlie Munger, Nobel Laureates Paul Samuelson, William Sharpe, and Gary Becker (Princeton’51); respected endowment fund managers from Yale (David Swenson) and Harvard (Jack Meyer). Innumerable financial professors including Burton Malkiel (Princeton ’64). Journalists, financial authorities—the list is almost endless. What’s more, the giant $140 billion Federal Thrift Savings Plan is invested largely in index funds, along with trillions of dollars in the nation’s public and private pension plans. But perhaps the crowning endorsement comes from investors who have actually owned Vanguard 500 Index Fund during its entire history. Let me present a specific example: at a dinner held in September, 2006, celebrating the 30th anniversary of the fund’s initial public offering, the counsel for the fund’s underwriters reported that he had purchased 1,000 shares at the original offering price of $15.00 per share—a $15,000 investment. He proudly announced that the value of his holding that evening (including shares acquired through reinvestment of the fund’s dividends and distributions over the years) was $461,771. Of course that was a year ago. At the close of business yesterday, the value was $543,657. There’s a number that requires no comment!