John Bogle on Patience

My keynote message this morning, I suspect, will be the most basic: to earn the highest returns that are realistically possible, you should invest with simplicity. Rely on the ordinary virtues that intelligent human beings have relied on for centuries: common sense, thrift, realistic expectations, patience, and perseverance. Call them "character." And in investing, over the long run, character will be rewarded.

example, that the top quartile of funds provided annual returns averaging an imposing 4.8 percentage points above the Index during the 1970s and ended up 1.0 point behind the norm during the 1980s, a downward reversion of 5.8 points to the Index. By the same token, the bottom quartile fell 4.1 points behind the Index during the 1980s, but reduced that gap to -1.8 points during the 1990s, an upward reversion of 2.3 points. Even more strikingly, 33 of the 34 funds in the top quartile reverted toward the market mean during the 1980s, with two-thirds of the formerly superior funds actually falling behind the Index. For what it’s worth, that one exception is a fund which provided a remarkable annual excess return of fully 11 percentage points during the 1980s. However, it has performed an exemplary RTM maneuver so far during the 1990s, providing an annual return precisely equal to the Index, an equally remarkable 11 point annual mean reversion. (Over the past four years alone, it has lagged the Index by 5.6 points annually.) Sometimes, clearly, the manifestation of RTM may require patience. Now, the unmanaged Standard & Poor’s 500 Index is not only a tough target (because it operates in a theoretical world, bereft of operating and transactions costs) but an elusive one (because it has a strong bias toward stocks with the largest market capitalizations).

1977 we made the leap into fund marketing. We took the then-unprecedented step of eliminating all sales commissions, seeking to appeal to the financial advantage of investors rather than the financial advantage of distributors. And we took the final step in becoming the full-line mutual fund complex we are today by assuming our first investment management responsibilities just four years later, in 1981. After seven long years, our structure was at last in place. And in the ensuing 16 years we have built the assets we manage internally to some $150 billion, about 60% of our total asset base. It wasn’t easy, but I think we can mark persistence--call it determination if you will—as yet another attribute of leadership. Paradoxically, our persistence had to be accompanied by patience, another trait of leadership. My favorite example is our pioneering foray into market index funds—today, sadly enough, the “industry darling” or, God forbid, “hot product.” (I cannot abide such concepts.) Struck by the insight that matching the stock market at minimal costs would over time give a low-cost passively-managed index fund a near-certainty of outpacing the vast majority of high- cost actively-managed funds, we formed the first index fund in 1975. This grand and pioneering idea was scorned by others—”Bogle’s folly” was said more than once—but patience and conviction were rewarded as our $10 million in index assets at the outset two decades ago exceed $75 billion today.

(A personal note: I received just last week a letter from a shareholder who described me as “impatient for action, but patient for results.” That is probably fair enough.) To wrap up this litany, I put before you—both tentatively and humbly—a final attribute of leadership: courage. Sometimes the enterprise has to dig down deep and have the courage of its convictions—to “press on,” regardless of adversity and even scorn. We have been a truly contrarian firm in our mutual structure, in our drive for low costs and a fair shake for investors, in our conservative investment philosophy, in market index funds, and in shunning hot products, marketing gimmicks, and the carpet-bombing approach to advertising you see elsewhere in this industry today. Sometimes it takes a lot of courage to stay the course when fickle taste is in the saddle, but we stood staunch by our conviction that, in the long run, reality will inevitably override perception. Opportunity, foresight, a sense of purpose, caring, failure, persistence, patience, and courage—these are, I think, eight of the attributes of leadership that I’ve tried to inculcate in our enterprise. And, sort of paradoxically, in the waning years of my career, fate was to dictate that I best possess a few of these attributes myself.deal

with a human failure (of a rather different kind—heart failure) with all of the patience, persistence, and courage that I could muster when, a little over a year ago, I endured a 128-day hospital wait, on life-sustaining intravenous fluid, before receiving a heart transplant. Believe me, you can’t possibly imagine the sheer joy in my (new) heart as I speak to you this morning. How could I not exude energy, enthusiasm and delight in bringing you this message of challenge to you this morning: Draw on your own God-given talents and be a leader in whatever you decide to do with your own life. Let me close by speaking on leadership with some words rather more poetic than my own, written more than a century ago by the poet Arthur O’Shaughnessy. He opened his “Ode” with this inspiring stanza: We are the music makers, And we are the dreamers of dreams, Wandering by lone sea-breakers, And sitting by desolate streams; World-losers and world-forsakers, On whom the pale moon gleams: Yet we are the movers and shakers Of the world for ever, it seems. I first used this verse in one of my periodic “sermons” to the Vanguard crew way back in 1986. But I was stunned just three weeks ago when I heard the poem again, in its entirety, in Sir Edward Elgar’s inspirational musical version, composed in 1912.

I hope that I haven’t left you with the idea that the endowment fund is somehow large enough. It’s not nearly large enough to do what endowment funds have always done: Fund operations through thick and thin, good times and bad alike. And I’ve yet to hear of a single one that couldn’t handle additional assets that would enable it to spread its good more widely among its constituency. Even Harvard, at $20 billion, seems to need more! A substantial endowment fund is a necessity today—not just for schools and colleges and hospitals and museums, but for United Way communities. “Saving for a rainy day” is what an endowment fund is all about. I am told that the endowment is being managed intelligently—a 60/40 balance between bonds and stocks, with both portfolios being very broadly diversified. That’s an intelligent strategy for the tough conditions prevailing in our country today, just as it was in the ebullient environment that prevailed at the stock market high in March of 2000, just a year and one-half ago. So, I believe you can be comfortable in considering the endowment fund as a prime candidate for your giving program, currently and in your estate planning. A Word About the Financial Markets On that note, since you’ve been kind enough to hear me out on the subject of giving tonight, I might try to repay your patience by taking just a few moments to discuss the state of our financial markets today.

but his warmth and his patience with a mind far smaller than his own. When I wrote my first book in 1993 (Bogle on Mutual Funds), I asked him if he would be willing to endorse it. He said “no.” But to my utter astonishment, he offered to provide the foreword. A few excerpts: “99 out of 100 books written on personal finance are dangerous to your health. The exceptions are rare. Benjamin Graham’s The Intelligent Investor is one. Now it is high praise when I endorse Bogle on Mutual Funds as another . . . As a disinterested witness in the court of opinion, perhaps my seconding his suggestions will carry some weight. John Bogle has changed a basic industry in the optimal direction. Of very few can this be said.” Surely his highest accolade for the index fund came in Dr. Samuelson’s speech at the Boston Security Analysts Society on November 15, 2005, only a few years before his death in 2009: “I rank this invention along with the invention of the wheel, wine and cheese, the alphabet, and Gutenberg printing: a mutual fund that never made Bogle rich but elevated the long-term returns of the mutual-fund owners. Something new under the sun.” Those words from a giant—according to The New York Times “the foremost academic economist of the 20th century”—mean much to me, but it is the intellectual challenge, the friendship, and the unfailing support of this fine human being that I shall miss most profoundly.

For exceptional funds with exceptional past returns that are substantially superior to the market will regress toward, and usually below, the market in the future. Regression to the mean-I call it the law of gravity in the financial markets-is measurable and apparently almost inevitable. For example, in two studies of returns over consecutive decades, a remarkable 99% of top quartile funds moved closer to-and even below-the market mean from the first lO-year period to the subsequent 10-year period. There was only one single, solitary exception to the rule, a fund that ruled the world during the 1970s and 1980s alike. But so far in the 1990s, it has regressed magnificently, falling far below the market's return. Sometimes mean reversion requires patience! Make no mistake about it: the record is clear that top performing funds inevitably lose their edge. This industry is well aware of that certainty.most

are almost always terrible times to change investment strategies. The market, however fickle, has usually taken into account almost every eventuality. Pillar 12. Think Long-Term. Do not let transitory changes in stock prices alter your investment program. There is a lot of noise in the daily volatility of the stock market, which too often is “a tale told by an idiot, full of sound and fury, signifying nothing.” Stocks may remain overvalued, or undervalued, for years. Patience and consistency are valuable assets for the intelligent investor. The best rule: Stay the Course. During the past two years, the stock market’s noise has been the loudest in history as volatility has reached record highs. Millions of speculators are scared half to death, as they should be. But long-term investors must realize that, as greed turns to fear, much of the worry is already reflected in the lower level of stock prices. And even if it turns out we should be reducing our stock position until the decline is over, where on earth would we ever get the insight that tells us the right time to get back in? One correct decision is tough enough. Two sequential correct decisions—both made at the right moment—are nigh on impossible. Impulse is your enemy, and patience and consistency are your friends. Of my twelfth pillar of wisdom—Think Long-Term—I can only say, “Amen!” Please keep these Twelve Pillars of Wisdom in mind.

“Surviving Defeat, Surviving Victory”1 By John C. Bogle When I was paid the high honor of being inducted into the FIASI Hall of Fame on November 10, 1999, I spoke about the triumph of indexing—the investment strategy based on passively-managed funds designed to track, at rock-bottom cost, the returns earned by broad market indexes of stocks and bonds, and to be held forever—a long-term investor’s entire investment lifetime. Then, I mentioned the struggle to survive the early defeat of the world’s first index mutual fund, founded in 1975. (Now known as Vanguard 500 Index Fund, tracking the returns of the S&P 500 Stock Index.) Before exploding upward in the late 1990s, our acceptance grew at a glacial pace. Similarly, our early municipal bond funds, first offered in 1977, were also slow to gain investor favor. But, defeated at the outset, both would survive, and then prosper. Patience! In my 1999 acceptance speech, I also expressed my concerns about the high growth rates and burgeoning assets that the Vanguard family of stock and bond funds were experiencing—then nearly $100 billion, now closing in on $5 trillion. Vanguard’s remarkable growth has been driven by our index funds, now numbering 59 stock funds, 18 bond funds, and 61 balanced funds (largely our target-date retirement funds-of-funds, a field in which our market share exceeds one-third). So I also wondered if we could survive victory.

S&P 500 Index). Indexing would prove to be the apotheosis of that “democratic ideal” of which Baltzell spoke earlier, the democratization of investing for our nation’s average citizen investor. But it didn’t happen in Boston. It would make Vanguard the dominant firm in the fund industry by an unprecedented margin. Vanguard’s novel structure (mutuality and low cost) and pioneering strategy (indexing) were essentially the tools that moved the mutual fund industry’s “Big Money” from Puritan Boston to Quaker Philadelphia. In retrospect, I have come to realize that my design for Vanguard reflects many of the basic Quaker values that William Penn fostered—simplicity, economy thrift, efficiency, service to others, and the conviction, in the words of George Fox, that “the truth is the way.” (I confess that I’m not so strong on some of the other Quaker values, in particular, consensus, patience, silence, and humility.) I take comfort in the fact that Benjamin Franklin too, struggled to balance his pride with humility. Here’s what he wrote in his autobiography: In reality, there is, perhaps, no one of our natural passions so hard to subdue as pride. Disguise it, struggle with it, beat it down, stifle it, mortify it as much as one pleases, it is still alive, and will every now and then peep out and show itself. . . . Even if I could conceive that I had completely overcome it, I should probably be proud of my humility.

follow hedgehog-like strategies. The goal is not necessarily to index—though that is clearly the most assured route to closely approaching 100% of the market’s rate of return—but to parlay a combination of very low cost, modest portfolio turnover, long-term focus, consistent style, and management competence—not thaumaturgy or legerdemain—into solid investor returns. Thereby exists the last, best chance to outpace the market index. The Hedgehog as Businessman Let me now turn to my second contrast between fox and hedgehog: From the mutual fund industry’s investment conduct, to its business conduct. Here the foxy strategy of entrepreneurs and promoters relies on guileful but expensive marketing, hot products, and drum-beating about past performance (when it is good), while the hedgehog strategy emphasizes patience, prudence, and stewardship. The hedgehog strategy entails a sort of “if-you-build-it-they-will-come” approach, which works only if standards are established to assure that those who do come are served in a first-class fashion. Since, in the long run, the rewards of investing are determined by the allocation of market returns between the fund shareholders and the managers and distributors, the hedgehog business strategy begins with low cost.

Dissecting the Impact of Costs With that background, let’s now take a careful look at the impact of costs on returns; using three charts (“scatter diagrams”) that largely update those that I presented to FIASI in 1998. They differ only slightly from one another in the message that they uniformly present: Beating the bond market is a loser’s game, largely because of the high costs—heavy sales charges and large expense ratios, and, to some degree, excessive transaction costs—incurred by the vast majority of bond mutual funds. The corollary of this message is equally obvious and equally important: The more the managers take, the less the investors make. There are too many types of bond funds to try your patience by examining all of them. So let’s examine the three basic maturity levels (intermediate-term, long-term, and short-term) that have become the industry standard, one in each of the three major bond segments—taxable corporate bonds, tax-exempt municipal bonds, and U.S. Government issues. We’ll start with taxable intermediate-term bond funds; then turn to tax-exempt long-term bond funds; and finally evaluate funds investing in short-term U.S. Treasury notes. Intermediate-Term Corporate Bonds Among intermediate-term taxable corporate bond funds, the Lehman 5–10 Year Credit Bond Index (the red star) set a demanding hurdle rate. (A finding that indexing wins should not surprise you!)

If one has the patience to wait 50 years, perhaps anything can find its way into the library. The First 50 Years was followed in 2002 by Character Counts, my fourth book, a collection of the speeches I had given to our Vanguard crew over the first three decades of our firm’s history, with some explanatory text added. My idea was to set down the truth about events as they actually happened, not only so that our history wouldn’t be rewritten by others, but so it wouldn’t be rewritten by me. I presented these speeches, warts and all, without editing, so they compose a sort of oral history, without the benefit of hindsight. The Battle for the Soul of Capitalism That brings me to my fifth book, The Battle for the Soul of Capitalism. As 2004 began, I had absolutely no plans—none, nada—for writing another book. But only until I received a letter from Michael O’Malley, senior editor of business and economics for the Yale University Press, who wrote: “I think that your next book will be your best. As your ideas begin to take shape, I was wondering if we might discuss Yale as the publisher of your work.”

Apparently ignorant of the time-honored rule “trust, but verify,” these managers flunked the due- diligence test. Paid such huge revenues for so little effort, they are a vivid example of one of Upton Sinclair’s timeless warnings, which I paraphrase here: “It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.” President Obama, Leadership, and Confidence My third and final subject is “where do we go from here?” We are facing the worst economic crisis of my adult lifetime (I was born just before the Great Depression, so I don’t remember it!), a financial mess that is enormous beyond imagination, and complex beyond the intellectual capacity of most (perhaps all!) of us. What’s more, the solutions that we are considering are without precedent—and therefore uncertain of success. Resolving the crisis and reforming the system will take patience and sacrifice—two traits that at the moment seem far from being the defining elements of our national character.

If that is the dual course you choose to follow, however, dare I recommend that the lion’s share of your clients’ assets be committed to the former stay-the-course approach that has worked so well for me over, yes, now 57 years of investing in the mutual funds whose investors I’ve done my best to serve. But whatever course you choose to follow, I wish you every success. Less than a month from now, those who hold the CFP designation will be required to honor an explicit standard of fiduciary duty that I’ve talked about for more than a decade. I’m sure that the overwhelming majority of financial planners have observed such a standard throughout their careers, and I’m equally sure that such an approach has served your clients and your careers alike. If my thoughts today have increased your focus on investment rather than speculation; on setting your expectations for future stock and bond returns, not on history but on their known sources; and on demanding that the firms whose mutual funds you offer to your clients focus less on innovation and more on substance, then, I’ve achieved what I’ve attempted to achieve in these remarks. Thanks for your patience, and for your attention.

And the prospects seem increasingly dim for opening even a tiny crack in the rigid regulatory doorway that precludes owners from their rights of ownership by denying them reasonable access to corporate proxy statements. With mutual fund managers firmly ensconced in the driver’s seat of the governance of the funds themselves, we are captives of a system in which both corporate directors and fund directors seem not only unwilling but unable to take on the role and responsibility of the gatekeeper as a steward, one who holds the interests of the shareholder as his highest priority. Summing Up So I await—with no great patience!—the return of the standard so beautifully described by Justice Cardozo all those years ago, excerpts from his words: Those bound by fiduciary ties . . . (are) held to something stricter than the morals of the marketplace . . . a tradition unbending and inveterate . . . not honesty alone but the punctilio of an honor the most sensitive . . . a level of conduct . . . higher than that trodden by the crowd.

and peers. But soon, perhaps, many others will ultimately see the light. Only last week the idea of governance reform got encouraging support from Professor Andrew W. Lo of M.I.T., one of today’s most respected financial economists: . . . the single most important implication of the financial crisis is about the current state of corporate governance . . . a major wake-up call that we need to change (the rules). There’s something fundamentally wrong with current corporate governance structures, (and) the kinds of risks that typical corporations face today. In sum, the change in the rules that I advocate—applying a federal standard of fiduciary duty to their clients for institutional money managers—would be designed in turn to force these managers to use their own ownership position to demand that the managers and directors of the corporations in whose shares they invest honor their own fiduciary duty to the holders of their shares. Finally, it is these two groups that share the responsibility for the prudent stewardship over corporate assets and investment securities alike that have been entrusted to their care, not only reforming today’s flawed and conflict-ridden model, but developing a new model that, at best, will restore traditional ethical mores. And so I await—with no great patience!—the return of the standard so beautifully described by Justice Cardozo all those years ago, excerpts from his words cited earlier in my remarks: Those bound by fiduciary ties . . .