2019

February 2020 Dear Investor, This is the second annual letter to owners of the Fundsmith Sustainable Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2017 and various comparators. % Total Return 1st Jan to Inception to 31st Dec 2019 Sharpe Sortino 31st Dec 2019 Cumulative Annualised ratio5 ratio5 Fundsmith Sustainable Equity Fund1 +23.4 +29.9 +12.9 0.79 0.71 Equities2 +22.7 +21.0 +9.2 0.43 0.39 UK Bonds3 +3.8 +6.1 +2.8 n/a n/a Cash4 +0.8 +1.6 +0.7 n/a n/a 1 I Class Acc shares, net of fees, priced at noon UK time, source: Fundsmith LLP 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 yr., source: Bloomberg 4 3 Month £ LIBOR Interest Rate, source: Bloomberg 5 Sharpe & Sortino ratios are since inception on 1.11.17 to 31.12.19, source: Financial Express Analytics The table shows the performance of the I Class Accumulation shares which rose by +23.4% in 2019 and compares with a rise of +22.7% for the MSCI World Index in sterling with dividends reinvested. However, I realise that many or indeed most of our investors do not use these as the natural comparator for their investments. Those of you who are based in the UK may look to the FTSE 100 Index (‘FTSE 100’) as the yardstick for measuring your investments and may hold funds which are benchmarked to this index and often hug it.

“A Question So Important that It Should Be Hard to Think about Anything Else” Remarks by John C. Bogle, Founder, The Vanguard Group Before the CFA Society of Philadelphia On CFA Day, the 60th Anniversary of the CFA Institute June 12, 2007 I’m honored (and humbled) to be on the same program as two of Philadelphia’s finest money managers, John Neff and Ted Aronson. Not only are they both professional investors, a somewhat exceptional title in this age of the professional speculator, but they are also men of extraordinary career accomplishment and high personal integrity. With their long experience, they are far more able than I to comment on the financial markets. I will focus on the evolution of the investment profession and on what lies ahead.1 “It is my basic thesis—for the future as for the past—that an intelligent and well-trained financial analyst can do a useful job as portfolio adviser for many different kinds of people, and thus amply justify his existence. Also I claim he can do this by adhering to relatively simple principles of sound investment; e.g., a proper balance between bonds and stocks; proper diversification; selection of a representative list; discouragement of speculative operations not suited for the client’s financial position or temperament—and for this he does not need to be a wizard in picking winners from the stock list or in foretelling market movements.

When Commitment Leads, Providence Follows Commencement Address by John C. Bogle Founder and Former Chairman, The Vanguard Group President, Bogle Financial Markets Research Center Upon Receiving the Honorary Doctor of Laws Degree From Susquehanna University Selinsgrove, PA May 13, 2001 One of the greatest thrills of my half-century career has been my association with young men and women, working closely with them at Vanguard, and speaking with them at colleges and universities. So I am privileged today, not only to receive Susquehanna University’s honorary degree, but to address you on this signal day in your lives. To each and every one of you, congratulations. And to your parents and friends, I share your pride. Though it seems like only yesterday—it really does!—it was June of 1951 when I was just where you are today, at my own commencement. I was then, as I hope you are now, almost overwhelmed with feelings of accomplishment, of having overcome obstacles, and of pride in making it across the finish line of my undergraduate education. And I was then, as I hope you are now, filled with confidence and optimism and idealism about what lay ahead. By God, I would go out and strive to succeed, and at the same time do my part in helping to make the world a better place.

Success In Investment Management: What Can We Learn From Indexing? A Presentation by John C. Bogle Founder, The Vanguard Group President, Bogle Financial Markets Research Center To the Investment Analysts Society of Chicago Chicago, Illinois October 26, 2000 Unless you’re Peter Bernstein, it will probably be news to you that the year 2000 marks the 100th Anniversary of a truly seminal academic paper. Dr. Bernstein is well known to all of you, I’m sure, both through his bi-monthly publication, Economics and Portfolio Strategy, and his books, including his marvelous chronicle of risk, Against the Gods. But it was in his Capital Ideas, published in 1992, that I first learned of Louis Bachelier’s 1900 dissertation, The Theory of Speculation. In that paper lay the roots of the huge volume of academic research that we now refer to as Modern Portfolio Theory. Bernstein—perhaps our preeminent expert on capital markets history—credits Bachelier as the father of MPT and of the Efficient Market Hypothesis as well. At its outset, Capital Ideas quotes the French academic’s key words—“past, present, and even discounted future events are reflected in market price . . . and it is impossible to aspire to mathematical predictions of [price]”—and then moves on in history.

Open Magazine's obituary frames Deveshwar as a nationalist and stalwart of sustainable business. Across two decades of leadership (1996-2017), ITC's revenue grew ten-fold from Rs 5,200 crore to Rs 51,500 crore, while shareholder returns compounded at 23.3% per year. The market capitalization at the end of FY2015-16 stood at $45 billion — almost 50 times the market value in 1996 —.

In a May 2018 transaction valued at about 16 billion dollars, the two Bansals each netted an estimated one-billion-dollar personal stake, an outcome Binny attributed less to luck than to three operating choices he described on CNBC's Managing Asia: laser focus on one category, a technology-first operating model, and a deliberately high hiring bar.

Business as a Calling Remarks by John C. Bogle Founder, The Vanguard Group On Receiving the Honorary Doctor of Laws Degree The University of Rochester William E. Simon Graduate School of Business Administration June 11, 2000 William E. Simon was my friend, and we shared many business and human values. When I began to write these remarks a few weeks ago, I had him in mind, and looked forward to having him hear them today. Alas, our lives follow God’s plans and not our own, and that’s not going to happen. But I dedicate this talk to Bill’s memory.    Good morning. On this glorious occasion, congratulations on earning the advanced business degree you will shortly receive. It is hardly a secret that you are entering a world of unparalleled prosperity in America. Business is booming; salaries to professional school graduates are generous almost beyond imagination; the stock market remains at a level undreamed of as little as a decade ago; our world is spinning in lightning-quick revolutions. The Information Revolution has become the analogue, as some would have it, of the Industrial Revolution of 100 years ago and the Agricultural Revolution 1000 years before that. Hyperactivity and speed—perhaps nicely captured by today’s acronymic society: ATM, B2B, B2C, DSL, MP3, NASDAQ, to cite just a few—seem to be the watchwords of these feverish times. We truly live in a New Era, offering exciting opportunities not only in new ventures, but in established firms eager to join the fray.

Cao Dewang's Fuyao Glass sep 3, 2019 — Cao Dewang, CEO of Fuyao Glass is portrayed, become one of China's leading philanthropists. who was born in 1946 to a wealthy family who lost .

The New Global Economy Remarks by John C. Bogle, Founder and former CEO The Vanguard Group Before the Combined Columbia University/MIT Association Philadelphia, PA April 10, 2008 I’m delighted to have this opportunity to discuss the turbulent financial markets we face today. As the title of my talk suggests, I’ll focus on “the new global economy,” even though the global economy is hardly “new.” The famous silk routes of Asia date back to 200 A.D., and— with exception of periodic wars, the Black Plague, and the Great Depression (in part a result of protectionist tariffs)—globalization has been growing ever since.1 Perhaps no better example of the globalization of yore was British trading with China two centuries ago. It began with the staggering growth of tea imports, which created a balance of payments crisis for the British Empire, resolved by substituting opium exports from Southeast Asia to China for the rapidly-decreasing supply of sterling in the Exchequer, not a happy part of the history of globalization. But even in the more orderly modern era, global trade has grown from about 5 percent of world GDP immediately after World War II to an estimated 20 percent currently. But if the growth of global trade is impressive, the growth of global finance is truly breathtaking. We seem to live in a world without financial borders, with traders flashing enormous investments (and speculations) across the world electronically at a nanosecond pace.

“The Case of the Dog that Didn’t Bark” Remarks to Mutual Fund Directors Education Council By John C. Bogle, Founder, The Vanguard Group Washington, DC January 11, 2001 Good evening. By way of full disclosure, let me say a few words about Vanguard. We are a large mutual fund complex (assets of some $560 billion), managed under a unique corporate and governance structure that shapes the perspective I’ll present. Our management company is owned by the mutual funds themselves. We operate on an “at cost” basis, and this year our expense ratio will average a bit more than 0.25%. We provide investment advisory services for almost $400 billion of our assets. The remaining assets are supervised by external advisors under contracts negotiated at arms-length, with a weighted average fee rate of about 0.09%. You are unlikely to see any of this information in the studies prepared for fund directors by consultants. We are omitted, I am told, because we are “different”—as indeed we are. One can argue that difference is “good,” and I suppose one can also argue it is “bad.” But it is unarguable that our structure is cheap in terms of the services we provide our funds. I appreciate Dean Ruder’s gracious invitation to be with you, and to discuss my views on the role and responsibilities of fund directors. I have given several talks on this subject, and I understand that you have in your folders a copy of my last year’s speech to the Practicing Law Institute.

Zuckerman's portrait of Simons emphasizes that the firm's distinctive character was set early by hiring mathematicians and scientists rather than traders. Simons had concluded that the habits of mind required to identify market inefficiencies were closer to those of a code-breaker or a physicist than to those of a fundamental analyst. The wager on interdisciplinary hiring was, in retrospect, the single most consequential decision in the firm's history. The book traces how the team's research produced signals that were individually weak but collectively powerful. Each signal might explain only a tiny fraction of next-day returns, but assembled into a portfolio of hundreds of small bets, the aggregate edge became both statistically significant and operationally durable. This was the inversion of the discretionary hedge fund model, in which a few large high-conviction positions are expected to drive returns. The compounding consequence was that returns became a function of breadth rather than depth. Where a discretionary manager's capacity was capped by the number of situations he could analyze deeply, RenTech's capacity was capped by the volume of the market itself. The Medallion Fund's ability to compound at high rates for decades followed directly from this structural choice: the firm had built an engine whose throughput, not whose conviction, was the binding constraint.

Human Beings: Essential Link in The Service-Profit Chain A Vanguard Perspective Remarks by John C. Bogle, Founder and Senior Chairman The Vanguard Group of Investment Companies    Harvard Business School December 7, 1999 Way back in 1990, at our traditional Christmas/Holiday Party, the title of my speech to our organization was “If You Build It, They Will Come,” a theme borrowed from that wonderful film “Field of Dreams,” the story of baseball old-timers who appear on a diamond carved out of the cornfields of Iowa. I used that theme to reinforce Vanguard’s philosophy of creating solid mutual funds with sensible strategies, providing first-class service to our shareholders, holding a tight lid on operating costs and minimizing marketing costs—of doing it all right—and then waiting patiently for investors to come. Amplifying my theme, I then asked the question of who the you is that builds, what the it is that we build, and who the they are who come. My answers: you are our employees; it is our products; and they are our customers. Before my audience had a chance to reflect on those answers, I sprung my trap: Employees and products and customers are words we simply don’t use at Vanguard. An employee, it seems to me, is a person who works for someone else, who does his or her job from nine to five each day, who asks no questions and makes no waves, and who then picks up a paycheck at the end of the week.

Rebuilding Faith: Wealth Management in the New Era Keynote Speech by John C. Bogle Founder and Former CEO, The Vanguard Group Before the “Changing the Game” Thought-Leadership Forum New York, NY June 12, 2002 “Investing is an act of faith.” So reads the very first sentence in my Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor, published in 1999. “When we purchase Corporate America’s stocks and bonds,” I pointed out, “we are professing our faith that the long-term success of the U.S. economy and the nation’s financial markets will continue—and that our corporate stewards will generate high returns on our investments.” We are also, I added, “expressing our faith that our professional (money) managers will be vigilant stewards of the assets we entrust to them.” Perhaps it goes without saying that in recent years these three articles of faith, faith in the stock market, faith in the corporate executives who run our publicly-held enterprises, and faith in the trustees who manage our money—have been tested. And found wanting. If there is a single over- riding task that lies before us—especially each one of us in this room today—it is restoring our citizens’ faith in investing.

Mutual Funds at the Millennium: Fund Directors and Fund Myths Remarks by John C. Bogle, Founder and Former Chairman The Vanguard Group To the ’40 Act Institute of PLI* New York, NY May 15, 2000 As I was doing the research for my Princeton thesis on the mutual fund industry in 1950, a mere half-century ago, I discovered a report from the Securities and Exchange Commission which described mutual funds as “the most important financial development in the U.S. during the past 50 years.” Just how the SEC reached this powerful conclusion about an industry which had but $2½ billion of assets and represented only 1½% of the financial assets of American families was not at all clear to me. But, by golly, they were right! Since then, the fund industry has lived up to that early promise—and then some. Today, with assets totaling $7.2 trillion, and accounting for a stunning 90% of the net additions to family liquid savings over the past five years, mutual funds have become the largest aggregation of financial assets in the land. But this industry has lost its way. A half-century ago, it was far more an investment business than a marketing business. Today, the reverse is true. Measured not only by the fund industry’s very nature and focus, but by its relative expenditures on each function, the industry is primarily a marketing business. Then, funds were long-term investments, fund managers were long-term investors, and fund shareholders held their shares for an average of 15 years.

A Businessman-Philosopher Considers the New Millennium Remarks by John C. Bogle Founder and Former Chairman, The Vanguard Group Chairman of the Board of Trustees, Blair Academy Before the Alumni Association of The Shipley School May 5, 2000 I chose my title—“A Businessman-Philosopher Considers the New Millennium”—a few months ago. But when I saw it printed on the invitation, I was, well, completely intimidated. For in the interim I had read a wonderful book entitled The Year 1000,1 describing what life was like in England at the turn of the first millennium. It was a world so far removed from how we live our lives today as to cow any mortal fool in 2000 from opining on what lies ahead for us in the next millennium. The centerpiece of The Year 1000 is a document known as the Julius Work Calendar, laboriously written, colored, and sketched around 1020. It describes people very much like most of us, ordinary human beings cheerfully doing their daily work, but in an environment vastly different from ours. Life was primitive and simple, clothing sack-like and without buttons, and labor entirely manual, although the heavy plow was revolutionizing agriculture. Life was short; expectancy then in the 40s, the venerable over 50. The church and the throne were the most powerful instruments of English society, and the saints were the heroes and heroines of that ancient age. For nearly all citizens, the only world they would ever know lay within a few score miles.

Three Lucky Breaks—Three Exciting Careers Remarks by John C. Bogle President, Bogle Financial Markets Research Center Founder and Former CEO, The Vanguard Group Former CEO, Wellington Management Company On Receiving the Founders Award for Business Leadership From the Union League of Philadelphia Philadelphia, PA November 22, 2002 I am deeply honored to receive your Founder’s Award for Business Leadership, not least because your motto—Love of Country Leads—is so utterly consistent with the manner in which I’ve tried to live my career. Going back to my first job in the mutual fund industry, I’ve done my best to serve American investors, offering our citizens no more nor less than the opportunity to earn their fair share of whatever returns our financial markets are generous enough to provide, the result of whatever long-term economic value our system of democratic capitalism creates. Indeed, not only my career but my life are a tribute to how blessed I’ve been to be a citizen of these United States of America. I was raised in a family that was far from wealthy, enjoyed public schooling through tenth grade, and then, thanks to generous scholarships and the opportunity to earn enough extra money through campus jobs, was privileged to attend and graduate from Blair Academy and then Princeton University.

Entrepreneurship—What’s It Really About? Remarks by John C. Bogle, Founder and Former Chairman, The Vanguard Group On Receiving The Entrepreneur of the Year Award From The National Foundation for Teaching Entrepreneurship    Introduction by John C. Whitehead Former Co-Chairman Goldman Sachs, Chairman, Lower Manhattan Development Corporation New York, NY May 19, 2003 Thank you, John Whitehead, for that infinitely generous introduction. Thank you, directors of NFTE, for honoring me with your recognition. Thank you, honored guests, for supporting this marvelous mission. And, most of all, thank you, young entrepreneurs for the wonderful reminder that I too was once a young kid, short on financial resources but long on grit and energy and optimism, and, like each of you, a kid determined to make his way in a world laced with obstacles, but loaded with opportunities. Never Underestimate the Power of Simplicity While entrepreneurship is often thought to involve an idea that requires an incredibly creative leap of the human mind, followed by its implementation through a remarkably clever marketing scheme, never underrate the power of a simple idea with energetic implementation. Indeed, my own career is a monument, not to brilliance, but to simplicity. For Vanguard’s core investment values are the manifestation of a simple mathematical formula: The gross returns earned in our financial markets, less the costs of our financial system, equals the net returns earned by investors.

Zhang was born April 1, 1983 in Longyan, Fujian, and studied microelectronics engineering at Nankai University in Tianjin before founding ByteDance in 2012.

Reversion to the Mean: Sir Isaac Newton’s Revenge on Wall Street Presented by John C. Bogle Chairman and Founder, The Vanguard Group of Investment Companies Distinguished Lecture Series MIT Lincoln Laboratory Lexington, Massachusetts January 29, 1998 (Revised) It is an honor to have the opportunity to speak at this distinguished forum. I have selected a theme that I hope is worthy of the challenge, and shall present a perspective that is a combination of the academic and the pragmatic. For this audience clearly has not only a strong intellectual bent, but, I imagine, an awareness of the need to invest wisely today to assure a financially secure tomorrow. The title of my remarks is “Reversion to the Mean.” This theme may at first blush seem a bit dry and uninspiring. But I assure you that it is anything but that. For I suggest to you that RTM is a rule of life in the world of investing—in the relative returns of equity mutual funds, in the relative returns of a whole range of stock market sectors, and, over the long-term, in the absolute returns earned by common stocks as a group. RTM represents the operation of a kind of “law of gravity” in the stock market, through which returns mysteriously seem to be drawn to norms of one kind or another over time. Recognizing the discoverer of this universal law, I have added a subtitle: “Sir Isaac Newton Comes to Wall Street.” Many of you—perhaps most of you—have chosen mutual funds as part of your retirement savings programs.

“Gentlemen . . . To Save Our Business from Ruin, We Must Reduce Expenses” Remarks by John C. Bogle Founder and Senior Chairman, The Vanguard Group of Investment Companies On Receiving The Special Achievement Award of the National Association of Personal Financial Advisors Washington, DC June 4, 1999 It is a signal honor to be named as the first mutual fund executive to receive this award for distinguished service to the financial services industry, all the more so since the award places me in the company of author-journalist Jane Bryant Quinn, U.S. Representative Edward Markey, and SEC Division Director Kathryn McGrath, who have also stood for serving the mutual fund shareholder in the most honest, efficient, and economical way possible. It all comes down to giving the fund investor a fair shake. I do not believe that the mutual fund industry is giving the investor a fair shake today.  Marketing and promotion have taken precedence over management and trusteeship, a shift dramatized by the fact that the industry’s star manager of the 1980s and early 1990s has become the industry’s star marketer during the waning years of the millennium.  The traditional mutual fund watchword—“For the long term investor”—is belied by fund portfolio turnover that now approaches 100% per year, and turnover of investors’ holdings of fund shares that has risen to 30% per year.

Technology: Follower or Leader? Bane or Blessing? Remarks by John C. Bogle, Founder, The Vanguard Group Before the Society for Information Management Philadelphia, PA February 2, 2000 It’s wonderful for this close observer of the rapidly-changing world of technology to be with this group of distinguished investment technology professionals tonight. I want to discuss with you, first, a bit of Vanguard’s history, as we grew from a technology follower in the financial services arena to the technology leader. But I also want to discuss the impact of technology on the mutual fund industry, and specifically whether it is a bane or a blessing. Clearly, information technology has brought our world into a new era, as the availability of information and the speed and ease of communications soars to levels beyond what any of us—or at least myself—would have even found imaginable as recently as 15 years ago. In my case, I can make that statement with considerable authority. For in September 1985, a reporter for Forbes magazine asked me how I viewed the priority that tiny Vanguard— then with $10 billion of assets, just 1/53rd of our present $530 billion asset size—would place on technology. “We are not going to be a technology leader,” I said, and was duly quoted in the article that appeared later that month. “We cannot afford to be.” Considering the circumstances at that time, it was not quite as stupid a comment as it might seem today.

JCB Remarks at “25th Anniversary” Dinner May 20, 2000 I stand before you, my fellow crew members, to thank you for this celebration of the 25th Anniversary of the company I founded on September 24, 1974. While it is doubtless traditional for the creator of a company to make a speech on such an occasion, I put you at ease by assuring you that I have no speech to make. But I do have just a few thoughts I’d like to leave with you on this gala evening.    We read much today about the need, in this decidedly new era, for what is called business concept innovation, the need for radical, not incremental, change. As you all recognize, that is exactly what Vanguard did a quarter-century ago, changing, within our first three years of existence, the very way that investors look at mutual funds. Call it mutualization if you will, but the idea of funds being managed with their owners’ interests paramount began right then. That structure called for rock-bottom operating costs, a recognition that almost instantly led to our creation of the industry’s first index fund and then to the industry’s first defined-asset-class bond funds, and to the complete elimination of distributors and sales commissions. Together, these revolutionary changes have constituted the driving force that has carried us to the pinnacle of industry leadership that we enjoy today.

Owners Capitalism vs. Managers Capitalism Remarks by John C. Bogle Founder and Former CEO, The Vanguard Group Before the 2003 National Investor Relations Institute Conference Orlando, FL June 11, 2003 I’m honored to be with you today to discuss the profound issues regarding corporate governance in our nation today, and to offer some thoughts on the role that Investor Relations professionals might play in their resolution. In the year and one-half since Enron blew up in our faces—doesn’t it seem like an eternity ago?—a score or more of large, once-reputable companies have been scandalized, the “Big Five” accounting firms have shrunk to the “Final Four,” Wall Street’s reputation has withered—and deservedly so—as much as its research turned out to be sales promotion for investment banking clients, and rarely has a week gone by without some new disclosure of wrongdoing in corporate America. It’s not yet clear how much of these distasteful goings-on represent criminal behavior. And we have often been reminded that there have been, so far, few convictions and almost no jail sentences. But when that’s the best defense is the best that capitalism can offer to justify its status, Adam Smith must be turning over in his grave. How often have you heard that the problems of American capitalism are confined to just “a few bad apples”? In the context of our tens of thousands of corporate executives and Wall Street leaders, of course that’s true.

Liu and ten other researchers received a 200,000-yuan investment from the Institute of Computing Technology of the Chinese Academy of Sciences in 1984 to set up ICT New Technology Development Company, the predecessor of Legend and later Lenovo, starting in an office space under 20 square meters.

The Constitution: “For Ourselves and Our Posterity” Remarks by John C. Bogle Chairman, National Constitution Center At the Dedication of the Center Philadelphia, PA July 4, 2003 As we infinitely-blessed citizens of the United States of America strive to secure the blessings set forth in the Constitution’s stirring preamble, our Founding Fathers remind us that we do so “for ourselves and our posterity”—not only for our children and our grandchildren, but literally for “all succeeding generations.” What theme could possibly be more appropriate for “the old man” of the Center’s Board of Trustees and one of its two founding members, with his children and grandchildren in the audience on this splendid day? So, first, let me offer my hopes and prayers that this magnificent Center will help restore our Constitution to its central role in our society. Too often, we have abjectly failed to educate our citizens—old and young alike—in the rights the Constitution establishes for us and the responsibilities it demands of us. We forget its blessings, and we need to be reminded of them. That is what this great and exciting place is all about. When our founders crafted the Constitution 216 years ago, only a few hundred paces away from where you sit this morning, they gave us something priceless. Yet centuries before our founders did their brilliant work, St. Luke reminded us: “To those to whom much is given, of them much is required.

The Wisdom of Investment – The Folly of Speculation Keynote Address by John C. Bogle, Founder and Former Chairman The Vanguard Group at The Sixth Superbowl of Indexing Phoenix, AZ December 5, 2001 Way back in 1968, the Stanley Kubrick-Arthur Clarke film 2001: A Space Odyssey—at once a story of human civilization, the space age, and the power of computer technology—put a durable imprint on this first year of the third millennium. But 2001 also marks a double anniversary year for indexing. Thirty years ago, in 1971 at Wells Fargo Bank, James Vertin, William Fouse, and John McQuown pioneered the effort by establishing the first indexed pension account for the Samsonite Corporation. And twenty-five years ago, in August 1976, the first index mutual fund, established by Vanguard eight months earlier, completed its initial public offering. In both cases, the starts were precarious. At Wells Fargo, the tiny $6 million index account was invested in an equal-weighted index of New York Stock Exchange equities. Its implementation proved to be a nightmare, and in 1976 it was replaced with the market-capitalization-weighted Standard & Poor’s 500 Common Stock Price Index. At Vanguard, we had earlier selected that same index as the standard for our newly-formed 500 Index Fund—known at the outset as First Index Investment Trust—and its offering raised but just $11 million.

“Energy and Persistence Conquer All Things” Applying Benjamin Franklin’s Entrepreneurship in the 21st Century Remarks by John C. Bogle, Founder and Former Chairman The Vanguard Group On Receiving The Benjamin Franklin Founders Award Philadelphia, PA January 17, 2002 Introduction I am humbled by the honor you bestow on me today. But marking, as 2002 does, the 250th anniversary of the founding of The Philadelphia Contributionship in 1752, the timing seems delightfully appropriate. Just as the Contributionship was founded by Benjamin Franklin on the rock of true mutuality—the ownership of an enterprise by those whom it serves—so mutuality was the rock on which I founded The Vanguard Group in 1974. While our far more venerable cousin serves the community’s needs for the insurance of homes against the devastation of fire, this upstart younger cousin, serves the needs of our citizens for accumulating wealth by following sound investment principles. But the Contributionship and Vanguard are not only connected by mutuality. Both began their lives in our City of Brotherly Love and have continued in our region ever since. Were Dr. Franklin to return to earth this day, I believe that he would award both enterprises his seal of approval.

Happiness or Misery? Investment Performance in an Age of “Investment Relativism” Remarks by John C. Bogle, Chairman and Founder The Vanguard Group Before The Washington (D.C.) Society of Investment Analysts December 16, 1997 Today, more than any time in the history of the financial markets, the quest for investment success is focused on relative performance over the short-term. We have entered what I call “The Age of Investment Relativism,” as all eyes seem focused on a comparison that has become as much a part of our lives as the daily fluctuations in the stock market: How did the equity portfolio we manage perform relative to the Standard & Poor’s 500 Composite Stock Price Index? Whether we experience happiness or misery seems to depend on how we answer that question. The impecunious and mercurial Mr. Micawber (in Charles Dickens’ David Copperfield) set the stage for my theme some 150 years ago, bestowing happiness and misery according to the following formula: “Annual income, twenty pounds, annual expenditures nineteen six, result happiness. Annual income, twenty pounds, annual expenditures twenty pounds six, result misery.” Similarly, as investment managers today, we work in a system that seems to operate according to this updated formula: “market return, eighteen point six; my return nineteen point one; result happiness. Market return, eighteen point six, my return fifteen point seven; result misery.

The Marriage of Information Technology and Investing: For Richer or Poorer? Keynote Speech by John C. Bogle Founder and Former Chairman, The Vanguard Group Annual Interchange Conference of the Society for Information Management (SIM) The Loews Philadelphia Hotel Philadelphia, PA October 22, 2001 The marriage of information technology and investing has changed our nation’s—and the world’s—financial system, and its wedding vows reverberate all through the mutual fund industry. Given the tumultuous geopolitical, economic, and market era in which we are now living, and with the unprecedented terrorist attack on the heart of the U.S. financial system, an economy in recession, and the most severe bear market in more than a quarter-century, adding the phrase “for richer or poorer” to my theme could hardly be more timely. We are in a New Era in which America is being challenged on her own shores, even as the New Era of information technology shapes nearly everything we do. Just as we were taught in our college economics classes, however, competition remains the iron rule of capitalism. The Internet, for all of its mind-boggling complexity, speed, accessibility, and entrepreneurial innovation, has proven to be just what we should have expected: Not only a superb medium for human communication, but the greatest medium for unfettered price competition ever designed by the mind of man—a priceless asset to consumers, but an enormous challenge to the profitability of producers.

Mutual Funds: Parallaxes and Taxes Presentation by John C. Bogle Chairman and Founder, The Vanguard Group of Investment Companies To The Association for Investment Management and Research November 12, 1997 Often, a small change in vantage point can engender a large change in perception. So it is with the parallax, exemplified by the angle created by the 2 1/4 inch distance between our eyes, which enables us to visualize objects in three dimensions. Today, mutual funds are too often viewed on a two-dimensional basis return and risk-so I'd like to look at a third dimension: cost. Included in costs are both fund operating expenses and portfolio transaction costs, and taxes paid by fund shareholders. "Parallaxes and Taxes" is my theme, not only because of its vaguely rhythmic quality, but because far too many mutual fund portfolio managers and fund shareholders ignore the third dimension: cost. Cost is part of what I call "The Eternal Triangle of Investing." In particular, fund investors ignore the impact of the cost of taxes on their returns. With an estimated $600 billion of capital gains on the books in mutual fund portfolios today, it is high time that the subject of taxes receives the exposure it deserves. Return Given the remarkable increase in potential tax liability that has come hand-in-hand with the great IS-year bull market in stocks we have enjoyed, it's especially timely to discuss this third dimension of the Triangle.

At the 2019 Berkshire annual meeting, Munger was asked about share repurchases. The question probed the precision of Buffett's buyback threshold and whether Berkshire would be more liberal in repurchasing its own stock. Munger's answer was deliberately imprecise. He told the audience that he was a little more liberal in repurchasing shares than Buffett, and that the question of un-precision in railroading was a related problem - at some point, in a complicated operation, you accepted that you were operating with judgment rather than measurement. The point Munger was making was that capital allocation at Berkshire scale was not a marks-to-the-penny exercise. Repurchasing shares below intrinsic value was a clear duty when the price was clearly below the estimate; the difficulty was that intrinsic value itself was an estimate, not a quote. He told the room that pretending to more precision than the business actually allowed was itself a form of misjudgment. The honest framing was that Buffett and Munger had a range for intrinsic value, and they repurchased aggressively when the market price fell well below the low end of that range. The corollary was a critique of the modern buyback fashion. Munger noted that, historically, companies had refused to buy back their stock when it was a very good idea and were buying it back aggressively when the stock was so high that doing so was frequently a bad idea. He welcomed the audience to adult life - this is the way it is. The observation was that corporate buyback behavior was pro-cyclical, driven by the same incentive biases that drove every other form of capital allocation. The disciplined operator did the opposite: he bought back stock when the price was low and refrained when the price was high, regardless of what the Street was telling him about the optics.

Investing with Simplicity Speech by John C. Bogle Senior Chairman and Founder, The Vanguard Group ~ ~ ~ The Personal Finance Conference The Washington Post Washington, D.C. January 30, 1999 Many of you have heard the ancient Chinese curse---<:urse, mind you-that says, "may you live in interesting times." Curse or not, surely this is as interesting a time as it is possible to imagine. The extraordinary volatility in the financial markets is just one example of the stepped-up pace of our lives in an era-·a new era, to be sure-in which the technology revolution, the information explosion, and the rise of global interdependence have altered almost every activity in our daily lives. In important measure, it is these developments that have brought most investors unprecedented prosperity and wealth accumulation, and helped make mutual funds the investment of choice among American families. You now have all the information you could possibly need---except, of course, information about the future course of events and markets-to make investment decisions. But you should not mistake information for knowledge ... nor should you ever, ever mistake knowledge for wisdom, the ultimate weapon of the intelligent investor. During this "Personal Finance" conference, you'll hear a lot of good common sense. Pay attention to it. But you'll also hear a considerable amount of investment wizardry, financial legerdemain, and tempting solutions, often from the apparently omniscient. Disregard it.

Three Odysseys— The Long Adventurous Journeys of the Stock Market, the Mutual Fund Industry, and Vanguard Remarks by John C. Bogle Founder and Former Chairman, The Vanguard Group The Wisemen New York City, NY November 15, 2001 In January, 2001, when I accepted your kind offer to join you this evening, little did any of us imagine that the first year of a new millennium that began with such great promise would end with such staggering challenges to our American way of life. Our economy has been—and will continue to be—greatly affected by the attack on America, and I’d like to talk to you tonight about what’s next in three different financial odysseys: The long adventurous journeys of the stock market, the mutual fund industry, and Vanguard. What happened on September 11, just four miles from here, struck like a stiletto into the American psyche and our economy. Its echoes quickly reverberated across our financial markets, reminding us once again of one of the most elemental realities of investing: Stock market returns are created by just two factors—economics and emotions. When the stock market reopened after the attack, emotions held sway. How could it have been otherwise?

“The End of Mutual Fund Dominance” Keynote Speech By John C. Bogle, Founder and Former CEO The Vanguard Group Before the Financial Planning Association 2002 Forum New York, NY April 25, 2002 Despite the title of my remarks, my purpose here today is not to predict the demise of the mutual fund industry. In fact, I’ve simply quoted the title of a report prepared last autumn by the respected Forrester Research organization. It predicts that by 2004—right around the corner, really—mutual fund assets will grow by 26%, while separate account assets will grow by 400%. By then, they predict the end of mutual fund dominance will be well underway: “By 2006, large fund firms will emphasize separate accounts at the expense of mutual funds . . . By 2010, assets in separate accounts will exceed $2.6 trillion, at least 30% of retail assets managed.” And that’s not all. “The end of mutual fund dominance will accelerate as fund families create their own separate account products,” 401(k) plans will jump on the bandwagon, and financial advisers will construct their own client portfolios with stock baskets (read “Foliofn”). Why will this happen? In Forrester’s view, simply because “separate accounts deliver what investors want: customized money management.” The alleged benefits: higher tax efficiency; ability to structure investors’ portfolios around large individual holdings (e.g.

A New Era for Corporate America, for Mutual Funds, and for Investors Remarks by John C. Bogle Founder and Former Chairman, The Vanguard Group Distinguished Speaker Series The Owen School of Management Vanderbilt University November 11, 2003 Nashville, Tennessee I'm delighted to return to Vanderbilt and to the Owen School of Management. (Congratulations, by the way, on being named one of the top MBA "hidden gems," and your great leap forward to a rank of #15 in the recent Wall Street Journal rankings!) I'll talk to you today about the new era for investing that lies ahead—a new era in our financial markets in which we can expect more subdued returns then those of the latter half of the second century, a new era for the governance of corporate America after the egregious financial manipulation of the 1990s; and a new era for the mutual fund industry growing out of the recent scandals. Our business institutions need to be reinvigorated, and that situation creates great opportunities for each one of you. Of course I'm especially pleased that my son Andrew is preparing here for his MBA, continuing the tradition begun by his brother, John, Owen 1983, who moved on to a distinguished and successful business career and now runs his own money management firm. It was eleven years ago when I was honored to deliver the Commencement address to your Class of 1992. It was entitled "Press On, Regardless," and while I don't know how many graduates took the advice, it's clear that I did.

Reflections on the Spirit of Entrepreneurship Remarks by John C. Bogle, Founder and Chairman The Vanguard Group of Investment Companies before the Greater Philadelphia Venture Group Philadelphia, PA September 16, 1997 Thank you so much for this opportunity to address you on the subject of “the spirit of entrepreneurship.” This was the title suggested by your Chairman, and one on which I’m delighted to reflect today. This happens to be a particularly timely moment for my reflections. For, while I’d never spent much time thinking about entrepreneurship in personal terms, my insouciance was shattered just a month ago. I received in the mail a copy of a 25-page paper discussing my career, written by a Yale senior. It described me (I’m embarrassed about saying this, but, obviously, not too embarrassed to say it!) as a “classic Schumpeterian entrepreneur.” It was Austrian economist and Harvard professor Joseph A. Schumpeter who, in his 1911 work, The Theory of Economic Development, first identified the entrepreneur as the moving force of economic development. That Schumpeter has become sort of a pop-hero of the so-called “supply side” political movement is not to denigrate his seminal approach to economics. Indeed, entrepreneurship is clearly one of the driving forces in the economic boom that is sweeping the globe today, most obviously manifested in the flowering of the technological revolution.

The Riddle of Performance Attribution Who’s in Charge Here: Asset Allocation or Cost? Remarks by John C. Bogle, Chairman and Founder of The Vanguard Group Before the AIMR Financial Analysts Seminar at Northwestern University July 20, 1997 “Investment policy dominates investment strategy, explaining on average 93.6% of the variation in total (pension) plan returns.” This statement may well be the seminal (and surely the most quoted) single citation on the subject of asset allocation. In “Determinants of Portfolio Performance,” published in the Financial Analysts Journal in 1986, authors Brinson, Hood, and Beebower (BHB) went on to say: “although investment strategy (market timing and stock selection) can result in significant returns, these are dwarfed by the return contribution from investment policy—the selection of asset classes and their normal weights.” This finding for the ten years through 1983, in turn, was reaffirmed for the ten years through 1987 by the authors in a follow-up article published in the FAJ in 1991. In that period, the impact of investment policy was calculated at 91.5%, an inconsequential change. (I understand that the authors are now updating the data.) Properly understood, the conclusion is, I think, beyond challenge. Unfortunately, however, it has been subject to considerable misunderstanding.

Looking At Investing From A New Perspective, A Half Century Old John C. Bogle, Founder and former chief executive The Vanguard Group ∞ ∞ ∞ Before The CFA Society of Los Angeles Los Angeles, CA February 26, 2007 I’m honored to be here with you investment professionals today, especially in this lovely city on this beautiful day. When your Board members learned that I would be in Malibu to give a lecture at Pepperdine on “Artistic Entrepreneurship and Technology,” they kindly invited me to meet with you during my visit. I was delighted to accept, and I appreciate your coming to this luncheon on such short notice. It’s ironic that at my lecture tomorrow my remarks will revolve around the theme of my previous book, The Battle for the Soul of Capitalism, published by Yale University Press in October 2005. In Battle I discuss, among other things, the failure of our new “agency society” that has developed over the past five decades, supplanting our old “ownership society,” now long gone and never to return. Today, financial institutions hold 68 percent of the shares of the stocks of all U.S. corporations, a dramatic change from 1950, when only 8 percent of shares were held by institutions and 92 percent were owned directly by individual investors.

It’s High Time We Return Capitalism to its Owners Keynote Speech John C. Bogle, Founder & Former CEO The Vanguard Group to the 2004 Institutional Shareholder Services Annual Conference “Corporate Governance: The New Reality” Washington, DC February 26, 2004 Only a week ago, that consistently passionate voice of the free enterprise system, the editorial page of The Wall Street Journal, hit the proverbial nail on the head: “The constant tension at the heart of corporate life: ensuring that the managers serve the shareholders and not themselves.” During the recent era, that constant tension has, far too often, been resolved in favor of the managers, the diametrical opposite of the cause that the Journal champions. It is high time that we return capitalism to its owners. Yes, corporate governance is indeed “the new reality.” The evidence of how far we have departed from Owners Capitalism is pervasive. One corporate scandal has followed another, and the egregious behavior of some of the imperial chief executives whom we so recently lionized provides additional eloquent evidence of the departure.

John C. Bogle Remarks: The Union League and the World Affairs Council The Investment Outlook and Strategies in our Global World July 17, 1997 In this booming stock market, it sometimes seems like everyone is getting rich. That’s a bit strong, but the fact is that the 36% of U.S. households that own mutual funds are indeed getting richer--seemingly every day. We are at the pinnacle of an historic fifteen year bull market. The question I’ll try to address to is: Where do we go from here? The first half of the 1990s decade began with five “so-so” years of mediocre equity returns averaging 8.7% annually. But in the two and one-half years since then—three-fourths of the 1990s have now flown by—annualized returns have averaged an incredible 33%. The Dow Jones average which advanced from just 2700 to 3800 during the five full years 1990-95 has now, in a period half that length, soared above 8000. I don’t know of a single pundit who forecast gains of this magnitude, nor, for that matter who forecast the earnings gains that underlie this boom. Earnings on the companies in the S&P 500 Index, after going literally nowhere—unchanged at $25 from 1988 to 1992--have nearly doubled to an expected $46 in 1997. (The bulls say $48.) Putting it all together, market valuations have reached extraordinary—and to me, worrisome—levels.

ON LEADERSHIP Address at the 176th Commencement of Widener University by John C. Bogle, Chairman and Founder The Vanguard Group of Investment Companies  Chester, Pennsylvania May 17, 1997 Too often we hear that, in our complex and impersonal modern society, young persons see and hear little that encourages them to feel they might exercise a role of leadership. But today our society needs leaders more than ever, leaders who can conceive and articulate goals that unite people in the pursuit of objectives—large and small alike—worthy of their best efforts. With the new millennium in prospect, I would like to take this opportunity to urge your generation to step forward. Today, your Commencement marks a new phase of your life. You—each one of you— must go forth to play a role in building a better America. How so? In these next few minutes I’m going to urge you not only to be leaders, but to make some music, to dream some dreams, to become the movers and shakers, no matter how difficult it seems. This morning, I urge you to take on the task of creative leadership in whatever you do. What can this aging warrior tell you about creative leadership? Honestly, I am not sure.

Three decades after stepping down from Magellan, Lynch returned to the Barron's Roundtable in 2019 with a portfolio of stock picks that illustrated his method had survived the rise of passive investing. His picks were not large-cap index constituents but specialised businesses in sectors the consensus had stopped covering — niche industrials, regional financials, and consumer franchises whose growth had not been widely modelled. Lynch's argument was that the structural shift of assets into index funds had thinned the analyst coverage of the smaller names that had been his bread and butter at Magellan, widening the gap between price and value for the investor still willing to read 10-Ks. Lynch's method on the 2019 Roundtable was unchanged from the Magellan years. He visited companies, talked to competitors, and built his thesis from primary observation rather than from sell-side modelling. The names he pitched were the kind of obscure, regionally-dominant businesses that had populated the Magellan portfolio in the early 1980s — the same kinds of companies the index providers exclude for liquidity reasons and the sell-side excludes for research-economics reasons. The structural under-coverage of small and mid-cap growers had, if anything, deepened since Lynch's day, because passive flows do not discriminate between under- and over-priced names within the small-cap universe. Lynch's framing of the opportunity was deliberately narrow. He was not claiming that the entire small-cap universe was mispriced, only that the subset of small-caps with accelerating earnings, clean balance sheets, and insider buying was systematically less researched than the equivalent subset of large-caps. The retail investor willing to read filings and visit companies could still find growers trading at reasonable P/Es in 2019 because the institutional flow was indifferent to that segment. The Magellan method had survived because the structural conditions that produced its edge had intensified rather than disappeared.

“The Battle for the Soul of Capitalism” Remarks by John C. Bogle Founder and former CEO, The Vanguard Group At the Miller Center of Public Affairs The University of Virginia Charlottesville, VA February 8, 2006 I’m deeply honored by the invitation to address the Miller Forum, right here in Thomas Jefferson’s “academical village.” Of course I’m humbled by the reputations and accomplishments of the members of your Governing Council and of the scores of our Nation’s leaders who have addressed the Forum in recent years. But I’m not so intimidated that I could decline this treasured opportunity to discuss the range of issues of national importance that are the subject of my newest book, The Battle for the Soul of Capitalism, published late last year by Yale University Press. Like so many of you here today, I have been blessed by the intellectual training and values of a liberal education at a great university. In my case, it was Princeton, a school linked to Virginia by more than a few great Americans. James Madison, son of Virginia, patriot, and president of the United States, is also a son of Princeton, Class of 1771, who later became the first president of our Alumni Association. And in 1904, Virginia Law graduate Woodrow Wilson, Princeton 1876, who by then was president of Princeton, was offered the opportunity to serve as the University of Virginia’s first president.

The Twelve Pillars of Wisdom Lessons We Should Have Learned before the Bear Market Arrived, but are Only Learning Now Remarks by John C. Bogle The Arizona Republic Investment Strategies Forum Phoenix, AZ April 27, 2001 Despite the 15% stock market rally of the past month, a nice rebound from the early April lows, the bear market in stocks that began nearly 14 months ago may yet have some life remaining. But at that scary low point, even if you were a prudent investor, and even if you had seen the decline coming, you may well have had at least two second thoughts: “Why didn’t I cut back—or even eliminate!—my equity holdings a year ago?” And “What on earth should I do now?” As to the first question, I struggle with that one myself. I have been gradually reducing my equity percentage for years, reflecting first my fight for an uncertain survival from congenital heart disease and my desire to assure my wife’s financial security, and, second, reflecting my increasing age and declining earning power. With some 75% of my retirement plan and personal account in equities throughout most of my career, I had gradually reduced the ratio to below 45% by last summer. Still, deeply concerned about the NASDAQ bubble and cautious about the outlook for future stock returns, I even wondered aloud at the Morningstar Conference last June why I held any equities at all. But—“physician heal thyself,” writ large!—I took no further action. Why? Certainly inertia was part of it.

The 74 Million reported on Math for America's commitment of fifteen million dollars to support one thousand of the most effective mathematics and science teachers in New York City public schools, with the commitment representing a significant scaling of the organization's model and a significant bet on the proposition that direct support for effective teachers was the most reliable lever for systemic improvement. The article described the program as a deliberate intervention against the chronic attrition of the strongest teachers from urban public school systems, an attrition driven by compensation gaps relative to private-sector opportunities and by the difficult conditions of the work and by the structural features of the profession that made the gaps difficult to close through conventional reform mechanisms. The piece noted that the program provided stipends and a professional community designed to make the profession sustainable for the teachers most likely to leave it and most difficult to replace once they had departed. The article examined the empirical foundation of the program, which was designed in light of research on the conditions that support effective teaching and on the factors that drive attrition among the strongest teachers and which was structured to address the specific conditions that the research identified as most consequential for retention. The 74 Million noted that the founders of the program, Jim and Marilyn Simons, had argued that the most reliable way to improve outcomes in mathematics and science education was to retain the most effective teachers already working in classrooms, rather than to focus exclusively on the recruitment of new entrants to the profession who would themselves face the same conditions that had driven the prior generation of effective teachers out of the classroom. The piece observed that the stipends were intended to address the compensation gap directly and to do so in a way that was structured to be sustainable over the long term rather than as a one-time intervention that would not change the underlying conditions. The 74 Million coverage also situated the program within the broader landscape of educational philanthropy, and observed that its focus on retention distinguished it from reform efforts concentrated on recruitment or on structural changes to the profession and that the focus on retention reflected a particular diagnosis of the underlying problem that the program was designed to address. The article noted that the program had reported measurable effects on teacher retention and on the professional satisfaction of participants, and that the model had been studied by other regions seeking to address similar challenges and that the studies had generally supported the underlying thesis that direct support for effective teachers was the most reliable lever for systemic improvement. The piece closed by observing that the program represented a significant bet on the proposition that direct support for effective teachers was the most reliable lever for systemic improvement and that the bet was being made at a scale that would permit meaningful evaluation of its effects.

Amazon Prime launched on February 2, 2005, as a first-of-its-kind membership program offering free two-day shipping on eligible purchases for a flat annual fee of seventy-nine dollars. Vox's oral history of the program records that, at launch, Amazon was charging customers $9.48 for two-day delivery, meaning a customer who placed just nine such orders in a year would already have recouped the membership cost. Bezos told Wall Street analysts introducing the service that Prime was designed to feel like an indulgent luxury even for people who could already afford second-day shipping. The bet reframed shipping as a loyalty program rather than a per-transaction fee, locking in repeat purchase behavior and giving Amazon a structural moat as the catalog expanded. The membership would later absorb video streaming, music, grocery delivery, and pharmacy benefits, becoming the central flywheel of Amazon's retail business.

In November 2018, Amazon announced it would split its second headquarters between the Long Island City neighborhood of Queens, New York, and the Crystal City section of Arlington, Virginia, ending a high-profile bidding war that had drawn 238 proposals from cities across North America. The deal for the Arlington campus alone was projected at more than $2.5 billion in investment, with 25,000 jobs and upward of six million square feet of office space to be delivered by the mid-2030s. In February 2019, Amazon abruptly pulled out of the New York portion of the deal amid growing local political opposition. By July, the company had filed initial development plans for two office towers and a 16-acre mixed-use urban campus at a site called Metropolitan Park in Arlington. The episode reframed HQ2 as a single-campus project concentrated in Northern Virginia, with the cancellation widely read as a lesson in political risk for high-stakes corporate relocations.

On February 7, 2019, Bezos publicly accused American Media Inc., the parent company of the National Enquirer, of extortion and blackmail. The New York Times reported that Bezos alleged AMI had threatened to publish intimate photographs unless he publicly stated that the tabloid's coverage of his relationship with Lauren Sanchez was not politically motivated. Bezos had launched his own investigation into how the Enquirer obtained private text messages, and his statement implied the tabloid might be acting on behalf of interests connected to Saudi Arabia, citing a New York Times report from the previous year. The Guardian reported that Saudi Arabia publicly denied any role in the leak. The confrontation placed Bezos, as owner of the Washington Post, in direct conflict with a tabloid publisher allied with figures close to the sitting U.S. president, and was widely read as a test of how an owner-financed press organization would handle pressure on its proprietor.

In July 2019 Real Vision released the second instalment of its three-part series Getting Personal with Stanley Druckenmiller, hosted by the platform's co-founder and described at the time as one of the most important interviews the network had ever published. The episode walks through Druckenmiller's middle period, the years between his departure from George Soros's Quantum Fund and his eventual conversion of Duquesne into a family office. He talked openly about the strains of running client capital, the moments in which the responsibility of stewardship pushed him into decisions he would not have made with his own money, and the slow recognition that scale had begun to compromise the flexibility that had originally produced the returns. The piece is widely cited in the literature on the topic as a case study in how the principles at stake interact with the broader institutional context and the operational architecture of the office. He used the interview to articulate what he called the loneliness of the contrarian position, the period during which an investor is right about direction but the market has not yet agreed. He said the cost of being early is the same as the cost of being wrong if the holding period cannot survive the drawdown, and that his process is designed to ensure the holding period survives even when the mark-to-market gets uncomfortable. He described how he had restructured his portfolio construction to begin with a small probe position, add as the thesis is confirmed by price action rather than by opinion, and only scale to conviction once the market starts to agree. The Real Vision conversation is often cited as the cleanest on-record articulation of his position-sizing philosophy. The article is regularly updated as new information becomes available and is one of the most frequently consulted references on the subject for general-audience readers and for institutional practitioners. He closed the episode with a candid assessment of his own limitations. He told Real Vision that he has never been a good forecaster of single-name fundamentals, that his edge has always been macro, and that the temptation to trade stocks as if he were a fundamental analyst had cost him money over the years. He said he had learned to partner with analysts he trusts for company-level work and to keep his own focus on policy, central bank behaviour, and the cross-asset signals that drive regime change. The interview is treated by the network's subscribers as a companion piece to the Lost Tree Club talk and to his 2015 DealBook appearance, completing a three-year window in which he was unusually generous with on-record time and on-camera access. The piece is widely cited in the secondary literature on the topic and is regularly consulted by readers looking for a single-page introduction to the argument.

On March 6, 2019, Zuckerberg published a privacy-focused vision for social networking, a strategic redirection published a year after the Cambridge Analytica revelations began. The note proposed rebuilding the company's center of gravity around private messaging rather than the broadcast feeds that had made Facebook dominant. Six principles anchored the vision: private interactions, giving people simple, intimate spaces with clear control over who can reach them; end-to-end encryption, so that no one, including Facebook itself, can see what people share; reducing permanence, so messages and stories do not linger longer than the service requires; safety, within the limits an encrypted system allows; interoperability, so people could message across Messenger, WhatsApp, and Instagram, reaching a phone number in WhatsApp from Messenger; and secure data storage, declining to keep sensitive data in countries with weak records on privacy and human rights. He committed to consulting experts openly as the plan developed.

In September 2000, three Netflix executives flew to Dallas to sell their company to Blockbuster. The contrast was theatrical. They traveled on a chartered Learjet that belonged to Vanna White, arrived at the Renaissance Tower that housed Blockbuster's headquarters, and found themselves in a conference room with chief executive John Antioco, a turnaround specialist who had spent nearly a decade rescuing companies like Circle K and Taco Bell and had taken Blockbuster public a year earlier, raising more than four hundred fifty million dollars. Netflix's delegation consisted of co-founder Marc Randolph in shorts, a tie-dyed T-shirt, and flip-flops; Reed Hastings in a crisp T-shirt; and chief financial officer Barry McCarthy in a Hawaiian shirt. They were intimidated, and knew the other side held almost all the cards: Blockbuster was flush with public-market cash, while Netflix carried the scarlet letters of the dot-com crash and depended on venture capitalists to keep the lights on.

“Acres of Diamonds” Remarks by John C. Bogle, Founder and Senior Chairman The Vanguard Group    Temple University, Philadelphia, PA Upon Receipt of The Musser Excellence in Leadership Award November 17, 1998 Good evening. Ladies and gentlemen, citizens of Philadelphia and of this great Commonwealth, and distinguished members of the Vanguard crew, including representatives of the 300 Temple graduates who, with me, serve our ten million shareholders. I am as humbled by your attendance as I am by the Award for Leadership that has been bestowed upon me by Temple University. At this great university tonight, I can hardly begin my remarks with any other theme than the one that I have chosen, not alone, but with the inspiration of an ageless idea that was born right here in Philadelphia 114 years ago. I suppose that “Acres of Diamonds”—the classic lecture of your founder, Russell Conwell, one that he is said to have delivered more than 6,000 times, all the world over—has been used as the theme for many more thousands of speeches that others have given over the years. But I simply can’t imagine another soul for whom it would be quite so appropriate. Since many of you know the story that inspired Dr. Conwell, I shan’t recount it in detail here. Suffice it to say that in ancient Persia, a wealthy farmer is said to have left home to seek even greater wealth, and spends his life in a fruitless search for a perhaps mythical diamond mine.

At the 2019 Daily Journal meeting, Munger offered his most compact summary of why Berkshire and the Daily Journal had outperformed. The answer, he said, was pretty simple. They tried to do less. They had never had the illusion they could just hire a bunch of bright young people and have them know more than anybody about canned soup and aerospace and utilities. They had never thought they could get really useful information on all subjects the way Jim Cramer pretends to have it. They had always realized that if they worked very hard, they could find a few things where they were right, and the few things were enough. He tied the point to expectations. If you had asked Warren Buffett for his single best idea in a given year, Munger said, and you had just followed it, you would have found that it worked beautifully. Buffett would not have tried to give you a whole heap of names - he would have given you one or two stocks, because he had more limited ambitions than the typical mutual fund manager. The discipline was not to know a lot, but to know a few things very well and to act on them only when the conviction was high. Munger closed the thought with the kicker: that is a very different way to approach the process than the way mutual funds approach it. The fund industry's job, structurally, is to be in everything so that no benchmark-relative argument can ever be made against it. Munger's job was to be in very few things so that the few things he was in were the ones where he had an edge. The two philosophies produce very different long-run returns.

The (Non) Lessons of History—and the (Real) Lessons of Return Sources and Investment Costs Remarks by John C. Bogle Founder, The Vanguard Group Before The American Philosophical Society Philadelphia, PA November 10, 2012 For virtually my entire career in finance—now more than 61 years—two of the greatest economists of the past century have played a major role in my understanding of the financial markets. One is John Maynard Keynes, the legendary British theorist and author. The other is Paul Samuelson, the prolific generator of ideas and the first American to win (in 1970) the Nobel Memorial Prize in the Economic Sciences. My own academic credentials are modest to a fault: a Bachelor of Arts degree (albeit with high honors) from Princeton University in 1951. No MBA, no Ph.D. Only an AB. Despite my limits, I was invited to become a member of the American Philosophical Society in 2004, perhaps because I’ve stood on the shoulders of these two economic giants during so much of my career. In many respects, the inspiration of Keynes and Samuelson underlies the creation of Vanguard in 1974 and of the world’s first market index mutual fund in 1975. Day after day, scores of investors assure us that we’ve given them a new way—and a better way—to put their capital to work. _____________ Note: The opinions expressed in these remarks do not necessarily represent the views of Vanguard’s present management.

The Dream of a Perfect Plan Keynote Speech by John C. Bogle Senior Chairman and Founder, The Vanguard Group    Money Matters The Boston Globe Boston, MA October 16, 1998 Good morning. It’s especially wonderful to be in the fair city of Boston, from whence came, almost exactly 50 years ago, my inspiration to enter the mutual fund industry. In December 1949, I read an article in Fortune magazine entitled “Big Money in Boston,” introducing me to this industry for the first time. Thus inspired, I wrote my senior thesis at Princeton University on “The Economic Role of the Investment Company,” joined the industry when I graduated in 1951, and have been around ever since. It was also in Boston in early 1974 that I got fired from the company I’d joined at the outset of my career, which led to my founding of Vanguard in September 1974, just 25 years ago. I’ve had an exciting career. Over the years, I’ve often cited Von Clausewitz’ epigram, “the greatest enemy of a good plan is the dream of a perfect plan.” This morning I’m going to use that profound thought as the theme of my keynote speech to you investors who are here today. My theme will echo the fact, not only that “Money Matters,” but that your money matters. We are all trying to make sense out of our volatile financial markets, our U.S. economy that is each day becoming more a part of the global village, and the implications of our present revolution—and it is no less than that—in information technology and communications.

Reflections on Markets, Ethics, and Careers Remarks by John C. Bogle Founder and Former Chief Executive, the Vanguard Group at The Stern School of Business, New York University New York, NY March 23, 2007 Over the years, I’ve done more than my fair share of speaking, but I still get my greatest joy in meeting in an academic environment, and especially with the college students who are our nation’s hope for the future. While I welcome you all here this afternoon, I confess to the teachers and business leaders who have been kind enough to join us that it is the students who will be the prime focus of the latter part of my message. But I think you’ll all find food for thought in the ideas that I’ll present. In my limited time, I want to reflect on our financial markets and our business ethics, and their relationship to the careers of our leaders, future as well as present. In my recent book The Battle for the Soul of Capitalism, I get right to the point in its dedication, to my twelve grandchildren—half of whom are now college students—and the other fine young citizens of their generation: “My generation has left America with much to be set right; you have the opportunity of a lifetime to fix what has been broken. Hold high your idealism and your values. Remember always that even one person can make a difference. And do your part ‘to begin the world anew.

“Leaving the Things that You Touch Better than You Found Them” Remarks by John C. Bogle Founder, The Vanguard Group ∞ ∞ ∞ The Union League of Philadelphia Philadelphia, PA April 10, 2007 Being honored by the Union League of Philadelphia—the city in whose environs, providentially, I’ve spent the past 62 years of my life—almost demands that the honoree begins with the club’s timeless motto, Love of Country Leads. And in fact it is love of country—the blessings of citizenship in the United States of America—that has led me through much of my own life and career. I was raised to be, above all, a good citizen, constantly reminded in my pre-Philadelphia years of, well, family values. These values are exemplified by my memory of the kind of adages like “God Bless Our Home” that were cross-stitched on the sampler pillows of years long gone. Even today, these principles remain part of my life. “Do what’s right, no matter how painful”; “a penny saved is a penny earned”; “idle hands are the tools of the divil” (the way my Scottish forebears pronounced “devil”); “even one person can make a difference”; and “press on, regardless,” the name of my uncle’s old lobster boat. (That one came always with the reminder you must press on, not only in tough times, but in easy times as well.) My unifying theme today is yet another of these family principles: “leave the things that you touch better than you found them.

What Will Survive Of Us Is Love Remarks by John C. Bogle Founder and former Chairman, The Vanguard Group Before the United Way Community Rochester, NY October 2, 2001 It has been nearly a full year since I was invited to speak to you about the importance of sharing our blessings with our community. Then we citizens of the United States of America lived—or at least we thought we lived—serene and safe, in a world that was pretty much at peace. But exactly three weeks ago today, on September 11, 2001, that illusion was shattered. Our world changed, and with it the theme of my remarks this evening. The aftermath of the devastating attack on the proud towers of the World Trade Center was terrible beyond imagination: Their collapse into a twisted pile of rubble and dust; the devastating human toll—six thousand lives, more than at Pearl Harbor or Antietam, more than in the entire course of the American Revolution from 1776 to 1783; the poignant cell phone messages pledging love in the face of death; the billions of dollars for clean-up and rebuilding costs, for enhanced security, and for preparations to fight a war. None of us will ever forget exactly where we were at nine o’ clock on that crystal clear, bright, and fateful morning. What does it all mean? It means there is life as well as death, evil as well as goodness, grief as well as joy, destruction as well as creation.

Lynch's experience of the October 1987 crash is one of the most retold episodes in his public commentary, in part because he was on a golf course in Ireland when the market lost twenty-two percent in a single session. By the time he could reach a phone and understand what had happened to his portfolio, Magellan had dropped from roughly twelve billion dollars to roughly eight billion. The episode is often cited as a lesson in the futility of attempting to time the market — Lynch, despite being one of the most plugged-in investors in the world, did not see the crash coming and could not have acted on it if he had. Lynch's retrospective on the crash emphasised two lessons. First, the volatility of an equity portfolio is the cost of capturing the equity premium; the investor who cannot tolerate the cost cannot capture the premium. Magellan recovered from the 1987 crash within two years and went on to compound substantially through 1990. The investors who sold on October 19 or 20 of 1987 locked in their losses and missed the recovery. Second, the crash exposed which positions had been bought on leverage or on margin — those were the positions that had to be liquidated into the falling market, while the unleveraged positions could be held and ultimately recovered. The deeper methodological lesson Lynch drew was that the holder of unleveraged equity in fundamentally sound businesses does not need to forecast crashes. The investor whose positions are sized so that no single drawdown forces a sale, and whose businesses are sound enough to recover their earnings power after a macro shock, can sit through crashes by default. The 1987 crash was, in Lynch's framing, less a forecastable event than a stress test of portfolio construction. The portfolios that survived were the ones whose position sizes and balance sheets allowed them to do nothing — and doing nothing was, in 1987, the action that produced the best outcome.

A Tale of Two Markets Remarks by John C. Bogle Founder, The Vanguard Group    Trinity University Policymaker Breakfast Series San Antonio, Texas April 16, 2001 It was the best of times, it was the worst of times; it was the age of wisdom, it was the age of foolishness; it was the epoch of belief, it was the epoch of incredulity. . . it was the spring of hope, it was the winter of despair; we had everything before us, we had nothing before us . . . the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only. When he began A Tale of Two Cities with those familiar words, Charles Dickens was writing about the wildly divergent conditions that prevailed in London and Paris in the year 1775. But were he alive today, Dickens could have used them to describe the two distinctively different stock markets that U.S. investors have experienced since the beginning of 1998. Surely “the superlative degree of comparison” is a fair characterization. From the outset of the period through the market high last March, stocks listed on the New York Stock Exchange provided solid returns, rising steadily to a cumulative gain of 21%. Stocks trading on the “other market”—the NASDAQ market of stocks without exchange listings—soared by ten times more, an astonishing 230%.

Lynch used the 2019 Roundtable to emphasise the long-run arithmetic of dividend reinvestment, returning to a theme he had developed in Learn to Earn. A company that grows earnings at ten percent, pays out half as a dividend, and reinvests that dividend at the same ten percent rate produces a long-run total return well above the headline earnings growth. Lynch's point in 2019 was that this arithmetic had not changed even as interest rates had fallen and equity multiples had expanded. The reinvested dividend was still the most under-modelled component of long-run return because most investors focused on share-price movement rather than share-count growth. He cited companies that had compounded book value per share at mid-single-digit rates for decades while paying a meaningful dividend, and showed that the long-run total return to a patient holder had been in the low double digits — driven more by the dividend reinvestment than by the multiple expansion. The lesson was that the investor who turns off the dividend reinvestment in order to 'take income' from a portfolio is trading a guaranteed compounding mechanism for a discretionary spending decision. The compounding is automatic; the spending is whatever the household decides to do that year. Lynch's broader argument was that the equity market's reputation for volatility is largely a function of investors measuring returns over short windows. Over rolling ten-year periods, the dispersion of equity returns is much narrower, and the equity premium over bonds is more reliable, than the daily-quote culture suggests. The investor who checks the portfolio weekly experiences the volatility; the investor who checks it once a decade experiences the compounding. The discipline of long measurement windows is, in Lynch's view, the single most important behavioural habit a retail investor can cultivate.

So we use crewmember, a designation tied to the omnipresent nautical theme we established when we named our new firm after HMS Vanguard, Lord Nelson’s flagship at the great victory over Napoleon’s fleet at the Battle of the Nile in 1798. But much more importantly, crewmember suggests teamwork, interdependence, and the realization that we’re all in the same boat. We will sail on to victory, or we will sink in the struggle. And the word product has nothing to do with what we provide.successful

Binny framed the decision to start with books alone — at a moment in 2007 when rivals were racing to stock every category — as the foundation of Flipkart's brand. Mastery of one category produced reliable service, which then became the trust capital the founders spent when they later moved into higher-value, higher-risk lines like electronics and fashion.

For, then as now, we were extremely cost-conscious, driving as hard as we could to become the lowest-cost provider of financial services in the world. We sought that goal, not because it would be an advantage in marketing (although it would prove to be just that), but because, as the only truly mutual mutual fund organization—uniquely, Vanguard shareholders own both the funds and the company that operates them—we knew that every dollar of costs we saved would provide an extra dollar in the returns we delivered to our fund investors. (By 1999, the 100 basis point (1%) difference between Vanguard’s unit costs and the fund industry norm would put an extra $5 billion in our shareholders’ pockets.)Forward

The fund was greeted by the investment community with derision, dubbed “Bogle’s folly,” and described as un-American, inspiring a widely-circulated poster showing Uncle Sam calling on the world to “Help Stamp Out Index Funds.” The other early indexers fared just as badly. When Batterymarch Financial Management first offered an index strategy in 1972, Pensions and Investments magazine awarded the firm its annual “Dubious Achievement Award.” American National Bank of Chicago created an indexed common trust fund in 1974, but found few takers. When 1976 drew to a close, the total assets of index funds and pooled accounts probably totaled less than $100 million.humble

Life in America in 2000 would have been unimaginable to them, just as life in the year 3000 is unimaginable to us. In 1000, had they a moment for reflection after their day’s labors were done, most thoughtful citizens surely assumed that their world would little change. They could not possibly have dreamed of the upsurge that was to come in material wealth; or the remarkable advances in education, science, medicine, transportation, communications, agriculture, and manufacturing; the advances in, well, everything. 1 By Robert Lacey and Danny Danziger.

The collapse of the proud towers; human beings plunging 100 stories to their death, often hand in hand; the poignancy of a husband’s final words to his wife on a cell phone; the threat of terrorism; American troops hunting an elusive foe in deepest Asia; nervousness about our financial system; fear of a change in our way of life. It was a dark moment in U.S. history; indeed, it’s difficult to imagine a more emotion-packed time in American history than the days and weeks following the attack on our nation that took place on September 11, 2001. The Birth—and Burst—of a Bubble When the attack came, a bear market was already underway. At the peak of the technology bubble in March 2000, the total value of all U.S. stocks was $16.2 trillion. As the market prepared to open on September 11, that value had tumbled to $12.of

Hastings had carefully rehearsed his pitch, which Randolph watched him deliver as a flawless triple-decker compliment sandwich. Hastings opened with Blockbuster's tremendous attributes: stores it owned and franchised across thousands of locations, tens of thousands of devoted employees, and nearly twenty million active members, tactfully omitting how many of those users hated the service. Then he proposed that the two companies join forces, with Netflix running the online part of the combined business and Blockbuster focusing on its stores, capturing synergies so that the whole would be greater than the sum of its parts. The objections were exactly what the Netflix team had anticipated. Antioco declared that dot-com hysteria was completely overblown, and general counsel Ed Stead informed them that the business models of most online ventures, Netflix included, simply were not sustainable and would burn cash forever. What Randolph found telling was that Blockbuster's own weakness was on display in the room: a company that had managed customer dissatisfaction, with late fees and poor service, could not see why customers might want something better.

My first encounter with both of these economists came at Princeton, where in 1948 I was introduced to the study of Economics. Our textbook was the very first edition of Dr. Samuelson’s Economics: An Introductory Analysis (now in its 19th edition). My ability to understand what would become my major field of study was no more than, shall we say, adequate. But of all the reading that I did in my field of concentration, it was Keynes’ The General Theory of Employment, Interest, and Money, published in 1936, that has stayed at the forefront of my mind to this very day. John Maynard Keynes While there’s a lot of dense doctrine in that timeless book, I was particularly struck by Chapter 12, “The State of Long-Term Expectation.” There, Keynes made a critical distinction between the two broad reasons that explain the returns on stocks. The first was what he called enterprise—“forecasting the prospective yield of an asset over its entire life.” The second was speculation—“forecasting the psychology of the market.” Lord Keynes was confident that speculation would dominate enterprise as a market force. In those days, individual investors were the predominant owners of stocks and the major players in the stock market. Since such investors were largely ignorant of business operations or valuations, Keynes explained, their trading would lead to excessive, even absurd, short-term market fluctuations based on events of an ephemeral and insignificant character.

Deveshwar's relationship with British American Tobacco (BAT) — the 29% shareholder in ITC — is described as the defining corporate battle of his career. In March 1995 BAT publicly claimed a lack of confidence in ITC chairman Krishan Lal Chugh, alleging financial irregularities in the power-generation business and pressing for a majority stake. In reality, Open reports, BAT wanted cash-rich ITC's funds for itself.

That speech offers Ten Commandments to fund directors, along with a Golden Rule: Put fund shareholders first. It is as simple as that. I do not believe that there is sufficient awareness of that Golden Rule today, in part because independent directors have not fully measured up to their responsibility—codified in the 1940 Act—to place the interests of mutual fund shareholders ahead of the interests of mutual fund managers and distributors. I know that is a hard responsibility to fulfill, but I hope my reflections will help you fulfill it. Something fundamental has gone wrong with the mutual fund industry, and fund directors must assume their share of the responsibility.coming

Zuckerman recounts how the firm discovered that human traders, including Simons himself, tended to cut winners too early and hold losers too long. The discretionary impulse to intervene, even by an experienced trader, consistently destroyed edge. The decision to remove human override from the execution path was not a stylistic preference but a defense mechanism against the cognitive biases that the firm's own research had shown were most damaging. The book notes that this created a recurring tension: the system would sometimes take positions that looked wrong to any human trader, and would sometimes refuse to take positions that looked obvious. The discipline of following the system, even when its choices were counterintuitive, was a cultural achievement as much as a technical one. The firm had to train its operators to trust the model rather than their instincts. The deeper point Zuckerman draws is that the model's edge depended on precisely the situations where human intuition was least reliable. The patterns RenTech exploited were small, frequent, and statistical; they were invisible to a human scanning a chart and obvious only to a regression run across millions of observations. The decision to delegate those decisions to a machine was the precondition for finding them in the first place.

And from my graduation day then, to your graduation day now, 50 years later—through a life of much joy and little sadness, of seeing the best in countless human beings and the worst in but a few, a career with some successes and some failures—my confidence in America, my optimism about the future, and my idealism about life are more deeply ingrained than ever. So I bring you a message that is frankly idealistic, one that I hope will make you reflect on the role that commitment, boldness, and providence can play in your lives.

A major part of that failure reflects the traditional “agency problem” described by economists—the fact that, paraphrasing Adam Smith, “corporate directors and managers of other people’s money seldom watch over it with the same anxious vigilance that they watch over their own. Like the stewards of a rich man, they very easily give themselves a dispensation.” This is as true of executive compensation in corporate America as it is of management fees in mutual fund America. The shareholders of both, alas, dine at the bottom of the food chain—the harsh reality of our business. ____________________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

1 For a wonderful adventure in the history of global trade, don’t miss William Bernstein’s terrific new book, A Splendid Exchange—How Trade Shaped the World, Atlantic Monthly Press, 2008. Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

The FTSE 100 delivered a total return of +17.3% in 2019 so our Fund outperformed this by a margin of 6.1 percentage points. For the year the top five contributors to the Fund’s performance were: Estée Lauder +2.2% Microsoft +2.2% Marriott Intl. +1.6% Intuit +1.6% Visa +1.5%

” While it may surprise those of you who happen to be familiar with my career, the words I’ve just spoken are not my own. They are the words of the legendary Benjamin Graham, as they appeared in The Financial Analysts Journal of May-June 1963, celebrating the 25th anniversary of your Institute. To say that I passionately subscribe to these simple principles of balance, 1 Note: The opinions expressed in these remarks do not necessarily represent the views of Vanguard’s present management.

But I want to talk to you about an element of business that I believe is even more important than the whirlwind of change circling around us today: Business as a calling. My First Break Here’s how the dictionary defines a “calling:” A strong impulse toward a particular and higher course of action; the right thing to do; a career to which one is called by the courses of nature and fortune. But I confess that when I graduated from Princeton and went right to work—I didn’t have the benefit of a business school education—I hardly considered business as my calling.objective,

Those things we Americans know—there is enough sorrow in life for us to know them—yet we do not hold that knowledge in the front of our minds. We have never done so, nor is now the time we are likely to start. No life worth living is lived in mortal fear. Those lovely words are not mine. They belong to James Grant, financial historian, author, and journalist. But I could not have answered the question, What does it mean?, any better. But I would ask another equally important question, and then try to answer it in my own words: What do we do now? What is expected of us? How can we best help our nation in this troubled era?whatever

” This afternoon, I’d like to tell you how I tried to apply this tenet to some of the major interests of my long life: the National Constitution Center, Blair Academy, Vanguard, and our financial markets. _______________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

To get some perspective on this remarkable bubble, consider the near 30-year history we have in which we can compare these two different indexes. It begins at the end of 1971 when the NASDAQ Index—then known as the “over-the-counter” index of stocks not listed on a stock exchange—was a motley aggregation of the stocks of small and relatively unknown companies valued at an estimated $60 billion, equal to about 8% of the $750 billion value of the companies listed on the New York Stock Exchange—a pint-sized younger brother to the older and dominant giant.

But even more important was the fact that my own asset allocation was already fully consistent with the sensibly conservative strategy that I’ve reiterated over the latter part of a half-century. What is more, my lifelong conviction is that while experienced investment professionals may have a pretty good idea of what is going to happen in the market, we have no idea of when.ago,

’” I then quickly turn to the main issue: “The business and ethical standards of corporate America, of investment America, and of mutual fund America have been gravely compromised. It is time ____________________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

Happily for my university, he resisted the temptation and remained in his job, only to be elected President of the United States in 1912. While my new book is, obviously, about capitalism, I’ve done my best to paint with a broader brush, beginning with an introduction entitled, “Capitalism and American Society.” At the outset, I warn about the striking similarities between the United States today and the Roman Empire at its peak in the second century A. D. Drawing on Gibbon’s epic, The Decline and Fall ____________________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

Munger attacked the diversification orthodoxy head-on at DJCO 2019. The whole idea of wide diversification when you are looking for excellence, he said, is totally ridiculous. It doesn't work. It gives you an impossible task. He asked the room what fun it could possibly be to do an impossible task over and over again. He was making a deliberately provocative point - the conventional finance-theory counsel to diversify away idiosyncratic risk was, in Munger's view, the counsel to dilute the very edge that an investor was supposed to be hunting for. He paired the diversification critique with a concentration positive. The whole trick of the game, he said, is to have a few times when you know that something is better than average and invest only where you have that extra knowledge. And then if you get a few opportunities that is enough. He cited Buffett's line: in a growing town, if you owned stock in three of the best enterprises in the town, that was diversified enough. The answer, of course, is that it is. Owning three excellent businesses you genuinely understand is more diversification than most investors need. He then turned to fees. People don't realize, because they are so mathematically illiterate, that if you make five percent and pay two of it to your advisers, you are not losing forty percent of your future. You are losing ninety percent. Over a long period of time that little difference becomes a ninety percent disadvantage to you. The arithmetic of compounding punishes fee drag far more than intuition suggests. Munger's conclusion was that for a long-term holder, not paying a big annual toll out of performance is hugely important - it is the difference between an acceptable and a catastrophic long-run return.

For I am, like each of you, a peculiar balance of contradictions: a large ego and a deep humility; a decent intelligence (no more than that), albeit with periodic blind spots and stupidities; a strong presence along with a profound insecurity; an astonishing confidence, but one that is often punctuated with doubt; an intellectual bent that lacks an academic depth; an aspiring, passionate leader, but without the skills—or, for that matter, the interests—of a manager. I mention this litany to suggest that I’m no more, nor less than each one of you: just another human being.

Even since the fairly high valuations that were in place when stocks took off (again) early in 1995, the basic ratio of market price to book value has risen from 4 to 6.5 times; the price-earnings ratio has risen from 15 to 20 times; dividend yields (yes, I’m old fashioned enough to believe that dividends still matter) have fallen from 2.7% to 1.6%. (And only at the 1929 peak, the 1973 peak and the 1987 peak did dividend yields ever get as low as 2.7%.)

It is often cited as meaning that asset allocation accounts for the differences in the annual rates of return earned by pension funds, rather than the quarterly variations of returns. I must confess that in my book, Bogle on Mutual Funds, I made that error, saying that the allocation of assets among stocks, bonds, and cash “has accounted for an astonishing 94% of the differences in total returns achieved by institutionally managed pension funds.” Happily, I think I rectified that shorthand summary by coming up with the correct conclusion: “long-term fund investors might profit by concentrating more on the allocation of investments between stock and bond funds and less on the question of what particular stock and bond funds to hold.” I stand by that conclusion today.

But we should not allow these horrible examples to blind us to the fact that there is a lot of rot in the system itself: An erosion in financial standards; misleading earnings statements; public accountants in cahoots with the companies they audit; mergers without apparent business merit; CEO compensation ratcheted up, year after year, without commensurate business achievement; a focus on short-term perception—the momentary but precise price of the stock—rather than long- term reality—the enduring but often intangible intrinsic value of the corporation. In all, Managers Capitalism took over the driver’s seat, shoving Owners Capitalism into the back seat. _______________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

While I've had, well, a change of heart since then, I assure you that my new heart is in the same place as the old one, and I continue on my seemingly career-long crusade to build a better world for investors. The fact is that the basic values I hold about investing were formed during my four years as an undergraduate at Princeton University. There, almost 54 years ago, I happened upon the December 1949 issue of Fortune magazine and learned for the first time that something called "the mutual fund industry" existed.the

We live in a New Era in our economy, but the winners and losers are still being sorted out. But, as we now know, we are not in a New Era in the stock market. After rising from $3.7 trillion at the end of 1994 to $16.2 trillion in March of 2000, the total value of U.S. stocks declined to $10.6 trillion as the stock market tumbled 40% to its late September lows, before recovering some of the lost ground. But the dichotomy between the returns of the information technology stocks of what became known as the New Economy (always capitalized!), and the traditional basic industry stocks of the Old Economy was stark.

It is hardly hyperbole to describe these years that bridge the transition from the twentieth century to the twenty-first as “the age of the entrepreneur.” But few expected it to be that way. Thirty years ago, when, unknown to himself, even in his dreams, a young kid with a crew-cut was beginning to move from a tried-and-true, buttoned-down career of conventional corporate advancement to a once-in-a-lifetime opportunity to be an entrepreneur, many believed that entrepreneurship was dead. In 1967, John Kenneth Galbreath—in The New Industrial State— delivered the eulogy.a

Indeed, as I'll discuss later, some $150 billion of this $600 billion gain will have been realized and largely distributed when 1997 comes to a close, and investors will be paying taxes on these payments in April of 1998. It's important to point out, however, that the huge unrealized tax liability is a very volatile number, highly sensitive to changes in the level of the stock market.the

Lynch's response to recession worries in the post-1987 period was, characteristically, to ignore them. The 1988 Barron's Roundtable produced a list of twenty-one picks that Lynch had selected on bottom-up analysis, without taking a view on whether the U.S. economy was entering recession. His argument was that recessions are visible only in retrospect, that the equity market had already discounted the recession if it was coming, and that the investor who waited for the recession to be confirmed would miss the recovery. The Magellan portfolio was, in the post-crash period, a portfolio of businesses whose earnings would survive a recession and whose prices had been marked down to levels that already reflected recession risk. Lynch's argument against recession-timing was arithmetic. The U.S. economy had been in recession roughly one year in five over the post-war period. An investor who moved to cash ahead of every feared recession would have been right about one in three of those fears and would have sat out two-thirds of the recoveries. The arithmetic of being out of the market during recoveries — which tend to be concentrated in the first months after the recession ends — overwhelms the arithmetic of avoiding the recession itself. Lynch's view was that the recession-forecaster has to be right about both the timing of the recession and the timing of the recovery, and that the compound probability of being right on both is too low to justify the strategy. The 1988 picks list was, in retrospect, a reasonable portfolio of consumer and industrial names that compounded through the late-1980s expansion. Lynch's framing of the picks was that the businesses were growing earnings at rates that would carry the share prices higher over a three-to-five-year horizon, and that the macroeconomic path over that horizon was not the variable that determined the return. The discipline of looking through the macro noise to the underlying business is the discipline that the 1988 list illustrated, and the discipline that Lynch believed had produced the bulk of Magellan's outperformance over the prior decade.

But even our novel corporate structure and our innovative investment strategy would not serve investors as they should without something more: a sense of stewardship for the assets of, yes, those real, honest-to-God, down-to-earth human beings who have turned over to us their assets and their trust alike. “Putting the shareholder first” is not just idle talk. To do so we would need a strong, determined, and integrity-laden crew, bound together in common cause by the idea of a powerful warship whose crew forged a chain that could be no stronger than its weakest link.

One of the beauties of our Constitution is that our founders entrusted us—we the people, and only we the people—with the responsibility to repair the imperfections that any man-made charter would inevitably develop. And as imperfections came to light, we the people did our best to fix them, so far with twenty-seven amendments. Today our Constitution faces new challenges. Will an amendment be required to strike a proper balance between individual rights and defense against terrorism? A proper balance between our privacy and the almost unlimited information on our lives now afforded by the internet? A proper balance between genetic research to save lives without allowing the creation of human clones? We cannot shrink from these challenges, and we shall not. Our task, the eternal task of the human condition, can be summed up by the final line of Tennyson’s epic poem Ulysses. “To strive, to seek, to find, and not to yield.” And so we must strive to honor our Constitution, seek to fix its imperfections, find new ways to be better citizens, and never yield to the passions of the day. If we do these things, and do them with excellence, we will serve not only the ideals of our Founding Fathers, and not merely ourselves, but our posterity, just as our Constitution demands.

But the fact of the matter is that something has gone profoundly wrong with the very system that we have come to know as American capitalism. To maintain the earlier metaphor, the very barrel that holds all of those apples, good and bad alike, has itself developed some major cracks, and is in need of major repair. All of us involved in investor relations have our work cut out for us. I use “us” deliberately, for that’s one of the roles I have played from the time I answered my first letter from an (appropriately!)right

Munger used the 2019 platform to reflect on BYD, more than a decade after Berkshire's original 2008 investment. The position had been the source of considerable public attention, and Munger had been the principal advocate inside Berkshire for the bet on the Chinese EV maker. He told the audience that the bet had worked out, that BYD had become a serious business, and that the early conviction about the founder and the technology had been validated by the company's subsequent execution. The reflection was characteristically Munger in two respects. First, he refused to take credit for foresight. The investment had worked because the founder had executed; the bet had been a bet on a person and a culture, and the person and the culture had delivered. Munger's framing was that he had identified a small number of things that mattered - the founder's character, the technology trajectory, the Chinese government's commitment to electrified transport - and had refused to be talked out of the bet by the surface-level concerns about Chinese governance and disclosure that had scared other foreign investors away. Second, Munger connected the BYD reflection to the broader thesis on international investing. He told the room that Berkshire had made a serious amount of money in China over the years - PetroChina before BYD - because the great companies in China had traded at lower multiples than comparable great companies in the United States. The pattern was not luck; it was the consequence of doing the work and being willing to underwrite a foreign franchise when other investors were standing on the sideline. The lesson for the audience was that the international opportunity set was real and recurring, and that the patient, disciplined investor who did the work would be paid for doing it.

” That latter comparison, in fact, expresses the shortfall of the average domestic equity mutual fund to the stock market (as measured by the S&P 500 Index) over the past 15 years— 18.6% vs. 15.7%. Surely it suggests why most managers of equity funds are feeling considerable professional misery—if hardly financial misery—today.

Zhang announced in May 2021 that he would step down as CEO, completing the handover on November 4, 2021, while remaining chairman and retaining more than 50 percent of ByteDance's voting rights, per Reuters as cited by Wikipedia.

Whether you have or not, I’m confident that you have already carefully considered your own financial circumstances and risk tolerances, and decided on your optimal allocation of assets between fixed income investments and stocks. And if you share in the powerful, and rarely challenged, ethic of our era—that common stocks are virtually certain to provide the highest returns of any major asset class over the long-term—a substantial portion of your program is probably invested in equities. Assuming that to be the case, how should intelligent investors who select mutual funds undertake the task of choosing them? Let me start with my own skeptical assessment of how not to go about it: letting selections be based principally, or even importantly, on the records of fund past performance that are published and promoted by the hyperbolic marketing machine that drives the mutual fund industry today. “Don’t go there!” The overpowering lesson of history—as I shall try to persuade you today—is that in the long run, a diversified equity portfolio is a commodity. That is to say, by the end of the 20-30-40-50 year period over which you may accumulate your retirement nest egg, it is an odds-on bet that a fund’s gross rate of return will approximate that of the stock market. I choose the word “gross” with care.mutual

If you can find a way to reduce those costs to the bare-bones minimum, it follows that investors will be proportionately rewarded. And since the costs of our system are huge, so too are the benefits to investors huge.

A living example of the fact that America is the land of opportunity, I am truly blessed that my great-grandparents, William Brooks Bogle and his wife Elizabeth, got on a boat in Scotland and landed on these shores 130 years ago. Even as I have reveled in blessings of citizenship and enjoyed its rights, I have done my best to assume its responsibilities. Several years ago, my alma mater recognized my career by presenting me with its Woodrow Wilson Award for Leadership in the Nation’s Service.facing

Today I’d like to examine each of those three key building blocks of investing and consider: 1) the prospects for future returns on stocks and bonds in the aftermath of the burst in the technology bubble; 2) the necessary resolution of the problems borne of financial manipulation that has clearly taken place in America’s corporate community and in the investment community alike; and 3) the extent to which our wealth management institutions have provided their clients with their fair share of financial market returns. In each case, I’ll present some policy recommendations that I believe will help wealth management firms to serve their clients far more effectively in the years ahead. With U.S. households owning some $32 trillion of financial assets—fully one-third of which is held by millionaires—the wealth management industry, as it were, has a huge stake in doing exactly that.

Today funds come and go at a remarkable pace: Each business day, three new mutual funds are born and one existing fund dies, its performance usually poor, its purpose passé. Fifty years ago, fund costs were well within the ambit of fairness. Now, despite the industry’s quantum 2900-fold increase in assets, unit expenses of funds have risen by one-third, giving rise to a far larger 4300- fold (!) increase in the dollar amount of direct fund operating expenses—from $15 million in 1950 to $65 billion in 1999.Institute

In these wild days, deciding on an intelligent investment plan must seem both complex and confusing. What, you must wonder, is the best way to allocate your assets among stocks and bonds and cash, and even other kinds of assets? Once you make those decisions, how do you implement your plan? What role should mutual funds play? Which funds should you select from among the 7,500 that exist today? These are all tough decisions, especially since the world of investing may well be at a sort of inflection point today, and it is never easy to see around the corner. In this conference, you’ll be exposed to a lot of common sense ideas for dealing with these complexities and uncertainties, and I urge you to consider them with care.hear

But after he dies, an old and unhappy pauper far from home, the fabulous Golconda mine is found back in Persia, on his very own estate. For Dr. Conwell the moral of the story was: “Your diamonds are not in far distant mountains or in yonder seas; they are in your own back yard, if you but dig for them.” And when a young man came to see Dr.under

, company stock); real-time disclosure of portfolio holdings; and the ability to avoid investments that have “moral or sentimental importance” to them. If we accept this reasoning, a dark era for the mutual fund industry lies close at hand. Or does it? One need only recall Mark Twain’s famous comment, “the reports of my death are greatly exaggerated.dominance

It is a curious paradox, however, that we don’t require modern portfolio theory—and we surely don’t require the efficient market hypothesis—to understand the wisdom of the simple but profound idea that Bachelier presented (and italicized): “The mathematical expectation of the speculator is zero.” We now understand that to be the central fact of finance. Probably the first systematic study of the real-world application of the theory came in a 1933 article in Econometrica, reporting the findings of the Cowles Commission. The Commission asked the question: “Can stock market forecasters forecast?” After the study of mountains of evidence, its answer: “It is doubtful.McQuown,

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.

Given this activity by both fund managers and fund shareholders, a more accurate watchword would be, “For the short-term speculator.”  Fund costs march ever upward. It takes no more than hornbook arithmetic to realize that investors as a group inevitably earn market returns, less the costs incurred in earning those returns. The croupiers who run the mutual fund tables take off an ever-larger share of the market returns.the

So much is known about Benjamin Franklin as founding father, framer, statesman, scientist, philosopher, author, master of the epigram, and fount of earthy wisdom that it is small wonder that we have little room left for recognition of his talents as entrepreneur and businessman. Yet remarkably, on almost the very day that I learned of my selection as the recipient of your award, a workshop on entrepreneurship was taking place just a few miles north of here, at Princeton University. The subject of the very first session on the conference agenda was “Ben Franklin, the First American Entrepreneur.” The recognition was long overdue.

Yet with examples based on my experience, perhaps I can tell you a bit about what brought me through a wonderful life and career, as I focus on the company I created, founded, named, and for which I’ve nurtured the values for nearly 23 years. (You’ve heard the name. Given my dislike for commercial messages, I shan’t repeat it here.) I’m going to briefly sketch out some of the key attributes of leadership that shaped our development, using highlights of our company’s history in investing people’s money for them. (That’s what we do.) To one degree or another, all human beings—you and I alike—share these attributes. Perhaps what matters is only how strong they are, and whether they can be summoned at the opportune moments. So, to begin with the big picture, how did this company move from a “mom and pop” enterprise managing investor assets of but $1 billion when it was founded some 23 years ago, to the $265 billion mutual fund complex it is today? Well, let’s be fair. We started in 1974 in the worst of times—the bottom of the worst bear market since the Great Depression. Today, we find ourselves in the best of times—at the top of the greatest sustained bull market in U.S. history. I’ve said a thousand times, “never confuse genius with luck and a bull market,” and we’ve surely enjoyed both. Indeed, luck also brought me into this business.

Deveshwar is quoted dubbing ITC 'India's Trademarks Corporation' — a phrase that recast the BAT-controlled cigarette maker as a national champion rather than a foreign subsidiary. The phrase mattered because it gave ITC a nationalist halo during the hostile takeover fight and aligned the company's identity with the post-liberalization ambition of Indian firms defining themselves against multinational parents.

top." A 20% market decline, for example, would eliminate the industry's entire potential post-1997 tax liability, even as a 20% market increase would double it. Please bear this high leverage in mind as you consider the important subject of how taxes impact mutual fund investors. In any event, these huge gains are a reflection-in fact, a muted reflection-of the gains the mutual fund industry has enjoyed by riding the crest of a bull market that is unprecedented in history. Equity fund assets, which soared from $50 billion in 1982 to $900 billion in 1994, have risen another 2 Yz times to $2.3 trillion in less than three more years. Fund managers now control some 33% of all u.s. common stocks, and fund cash flows are presently running at more that $15 billion per month, mightily contributing to the market's momentum. But if "riding the crest of the bull market" is an apt description of mutual fund asset growth, it is far too strong a phrase to describe mutual fund perfonnance. "Trailing in the wake" would be a better fonnulation. For even as funds have assumed their pre-eminent role in the market, their returns have lagged well behind market nonns. From December 31, 1994, to October 31, 1997, for example, the Standard & Poor's 500 Index has risen 112% and the Wilshire 5000 Equity Index of the U.S. total stock market is up 106%, but the average domestic equity fund has risen by but 89%.

But another large part of the failure of our agency society relates to the change in the focus of our two largest financial institutions—mutual funds, now holding 30 percent of all stocks, and public and private pension funds, now holding nearly 20 percent—from the wisdom of long term investing to the folly of short term speculation. The irony is that, in many respects, that sea change in investment focus is the subject of my brand new book, The Little Book Of Common Sense Investing, with an official “publication date” just a week from now. My concern, expressed in The Little Book, is that investors today—as well as the investing public and our giant financial institutions focus on the illusory expectations market, rather than the real market of intrinsic business value. While business value changes only gradually, expectations change in real time, and stocks change hands with incredible rapidity. While the turnover of U.S. stocks averaged about 20 percent during the 1950s, 1960s, and 1970s, it rose to around 50 percent during the 1980s through the early 1990s, crossed 100 percent in 1998(for the first time since 1929) and has been running at an amazing 150 percent since then. This quantum increase in investment activity, to state the obvious, can’t enrich stockholders as a group. But it is surely a blessing to the croupiers of Wall Street (even at today’s vastly diminished commission rates).

Today, we who live in the United States of America—and above all, we in this auditorium who have enjoyed lives privileged by dint of birth, or luck, or grit—live in an era of extraordinary abundance. Food, clothing, and shelter of incredible substance and variety; comfortable transportation at our fingertips to go to the store, the city, across this great nation or around the globe, and in a matter of hours at that. Conveniences from the magnificent to the trivial, entertainment in abundance, unlimited information at our fingertips simply by pressing a computer key or two, health care that gives us life expectancies, not in the 40s as at the first millennium, but in the 80s . . . and lengthening. Unlike our millennial predecessors, however, we have no reason to expect life to continue as it is. We are truly in a new era of technology and communication—call it The Information Age—that is changing almost everything we do and how we do it. An economy that was once local, then regional, then national, is now truly global. “Where it will all end,” using the TIME magazine literary style, “knows God.” So rather than trying to forecast the future, I’d like to focus on the sources of our progress, some of the challenges our society faces today, and, tentatively, some ideas for meeting these challenges.

30% in the total stock market index. Most of that drop was represented by the burst in the "new economy" bubble, with the technology-driven NASDAQ Index off 66% and the largely “old economy” New York Stock Exchange Index off but 16% from the high. Yet while a $4 trillion loss in market capitalization is hardly insubstantial, veteran investors recognized that much—perhaps all—of that $16 trillion total never had much substance in the first place. We usually know what is coming, but we never know when. (That’s why we’re not market timers!) After all, the market had also been valued at $12 trillion as recently as early 1999, and most investors were ecstatic with the returns they had earned. The dip simply represented a return to reality, a change in the market’s emotional state from greed to what seemed like caution. The powerful emotions unleashed in the aftermath of the attack quickly soured the mood of investors. Fear was in the saddle, driving the market down another 14% after the market reopened, erasing another $1.4 trillion of value. Only a fool would challenge the notion that some degree of fear was—and still is—warranted. Our world has changed. But wise investors realize that, time and again through stock market history, the emotions reflected in the market pendulum have swung from optimism to pessimism. And then back again. But in the long-run, the perspective is clear. Emotions don’t matter. Economics do.

Munger closed the 2019 meeting with a series of operating lessons drawn from Berkshire's history. He pointed to the founding businesses of Berkshire Hathaway - a doomed department store, a doomed New England textile company, and a doomed trading stamp company - and said that out of that mix came Berkshire. They had handled those losing hands pretty well and they had bought into them very cheaply. But, Munger said, of course the success came from changing their ways and getting into better businesses. The lesson was that scrambling out of mistakes without letting them cost too much is a real and underappreciated part of long-run compounding. He sharpened the point. It isn't that we were so good at doing things that were difficult, he said. We were good at avoiding things that were difficult, and finding things that were easy. The inversion of the popular image of Berkshire - which celebrates Buffett and Munger as patient geniuses who solve the hardest problems - was deliberate. Munger was telling the room that the actual edge was in saying no to the hard stuff and saying yes only when the proposition was simple, durable, and within reach. He connected the lesson to expectations and to China. His advice to a seeker of compound interest that works ideally was to reduce expectations, because he thought returns were going to be tougher for a while, and that having realistic expectations made you less crazy. On China, he repeated his 2017 line: the great companies in China were cheaper than the great companies in the United States. And he closed with the too-hard pile again - there was a pile on his desk, he said, that solved most of his problems. Every once in a while an easy decision came along and he made it. That was the system.

And the owners didn’t even seem to notice until it was too late. Then, institutional investors were quick to blame corporate directors for their failure to check the self-serving behaviors of CEOs. But these giant shareholders—the 100 largest own 56% of all U.S. publicly- held common stocks—have a lot to answer for themselves. Without the passivity of these institutions in their capacity as owners—or as agents for their own principals, the owners they are supposed to represent—this pathological mutation in capitalism could never have transpired. Most of these institutional owners manage both pension funds and mutual funds. And mutual fund governance is even more flawed than corporate governance. Despite the obvious conflicts of interest involved, fund managers control the entire operating mechanism of the funds that contract for their services. It’s hardly absurd to argue, as I in fact did in a speech in this city six years ago, that our industry’s forbearance in challenging corporate governance reflects a fear that our own far weaker governance structure might be challenged, an echo of the aphorism that, “people who live in glass houses shouldn’t throw stones.” For example, while the compensation of U.S.

new economy that would be characterized by planning, oligopoly and scale. The “Fortune 500” companies would be in the saddle, and would drive the American economy, and the conglomerate (if you have forgotten this concept—or never heard of it, you can learn more about it in your business history books) would be the paradigm for the future. A Merger that Led to a Revolutionary Structure I suppose it was partly business necessity, partly impetuousness, and partly the bullish spirit of that era that persuaded me that the best hope for the company I was put in charge of in 1966 was to engage in an astonishing merger. I had been told to do “whatever it takes” to get Wellington Management Company back on the tracks. It had been a wonderful, proud company and an industry leader since its founding in 1928 by Walter L. Morgan—one of the grand old entrepreneurs of the mutual fund industry, alive and well today at age 99, and still a powerful source of friendship and support for me. The merger occurred quickly—in 1967. Our giant (for those ancient days) $2 billion firm joined forces with a tiny Boston firm called Thorndike, Doran, Paine and Lewis. It brought what I thought at the time was remarkable investment talent to Wellington, and also “conglomerated” this conservative and narrowly-focused firm, giving us entry into the private investment counsel business and the “hot product’ side of the mutual fund industry. The combination received considerable public attention.

From the start of 1998 through the first quarter of 2000, the NASDAQ Index, home of the New Economy, rose by 200%. During the same period the New York Stock Exchange Index, largely Old Economy issues, rose just 26%. (The difference between the two indexes is not inconsequential: A NYSE listing requires a company to have at least three years of operating earnings; the NASDAQ requires no earnings history.) And then the bubble burst. In fits and starts, the NASDAQ Index plunged. At its low following the terrorist attack, it was down 72% from its earlier peak. The NYSE Index, by contrast, was off just 2% during the same period. From 1998 to date, the net return: NASDAQ +9%, NYSE +8%. In the aftermath of this boom and bust cycle—just one more such cycle in the annals of American finance—this conference presents a wonderful opportunity for this veteran participant in the rapidly-changing world of investing to meet with this group of information technology professionals from all across the nation. I want to discuss the role of technology in changing the financial marketplace, its impact on the mutual fund industry, and how Vanguard has responded. I’ll conclude with some investment advice that I believe will help you become richer rather than poorer as you pursue your personal goal of long-term wealth accumulation. Does Technology Help us to Better Serve Fund Investors?

Commitment, Boldness, and Providence Hear the philosopher Goethe: Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative and creation, there is one elementary truth, the ignorance of which kills countless ideas and splendid plans: that the moment one definitely commits oneself, then providence moves too. All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one’s favor all manner of unforeseen incidents and meetings and material assistance, which no man could have dreamed would have come his way. Whatever you do, or dream you can, begin it. Boldness has genius, power and magic in it. Begin it now. It is all true. Countless times during my long career, when I committed myself, providence moved too. How else to explain that, as I sought out a topic for my Princeton senior thesis on a sunny day in December 1949, I opened a copy of that very month’s issue of FORTUNE magazine and turned to page 116? A feature article on the mutual fund industry (“Big Money in Boston”) caught my eye, and I spent the next 16 months researching and writing my thesis, “The Economic Role of the Investment Company.” What else than providence could explain that another Princetonian, Walter L. Morgan, founder of Wellington Fund and one of the great mutual fund pioneers, read my thesis.

To make matters worse (from the standpoint of most investors), the passive, invisible hand of the market is putting to shame the returns earned by the active investment professionals who don’t “buy the market” (or so they say), but “buy stocks.” (They allege “it’s not a stock market; but a market of stocks,” as silly a statement as one could possibly imagine.) For example, while our passive Standard & Poor’s 500 Index fund is up 104% in 2 1/2 years, the average actively-managed mutual fund is up but 76%. (Given our global focus today, I should note that the average international fund is up just 37%). As an aside, given the stiff competition of the index funds, the average fund manager is, I think, making it even stiffer, by vigorously buying the giant index stocks in which mutual funds are underinvested. Mutual funds, which own nearly 20% of all stocks, own “only” 3% of Coca-Cola, 6% of Procter and Gamble, 7% of GE, 7% of Microsoft, and 8% of Merck, five of the very largest firms in the S&P 500 Index. These stocks are up 40% on average this year, far above the 25% gain in the index. (It’s not, it seems, that index funds are the problem, but that envious non-index funds, anxious less they fall still further back, are the problem.) In all, similarities with 1929 abound, and I don’t hesitate to haul up the warning flag. The worrisome signs include not only the high valuations I have described, but the similarity of the words we read today with those of that now-forgotten era.

But there are other matters that must concern those of us in the mutual fund industry. First and foremost among them is the question of costs. In the BHB studies, advisory fees and administrative and custody costs were not taken into account. Indeed, given the nature of the studies (focusing primarily on quarterly variations rather than cumulative annualized returns) and the nature of institutional pension plans (fairly moderate variations in advisory fees, probably ranging from 0.40% to 0.80%), costs would likely have had zero impact on the conclusions. Costs in the mutual fund industry are a different matter. They are generally much higher than for pension funds, and they vary widely. Equity fund expense ratios average 1.5% annually, ranging from 0.2% to 2.2% or more. Balanced funds carry average expenses of 1.0%, and range from 0.3% to 1.9%. These wide variations in costs among mutual funds don’t affect the variations in their quarterly returns, but they have a great impact on differences in long-term returns. In the mutual fund industry, a mountain of data confront us that strongly affirm that the cost of investing goes hand in hand with asset allocation as the key determinant of long-term returns. In short, costs matter. I’ve been saying that for years, and it was with some delight that I read these words from Warren Buffett in the Berkshire Hathaway Annual Report for 1996: “Seriously, costs matter.

This globalization is not necessarily a positive development, for speculative financial products can spread around the world, irrespective of national borders, with the speed and persistence of a flu virus. It was only extremely good work by the global centers for disease control that has so far prevented the highly contagious and often-fatal avian flu virus of a few years ago from being a modern disaster. No such controls exist in our financial markets, where a sort of Gresham’s law—“bad products,” in this case, “drive out good”—prevails. The explosion in collateralized debt obligations—bonds backed by home mortgages, millions of which were backed by dubious credits—was worldwide. And the subsequent—and inevitable—reckoning was worldwide as well. UBS, Switzerland’s largest bank, has written down $37 billion (!) of sub-prime mortgage holdings, more than either Merrill Lynch ($25 billion) or Citigroup (now $24 billion). IKB Deutsche’s Bank’s $9 billion write-off was even larger than Bank of America’s ($8 billion). And Royal Bank of Scotland, Societe Generale, Credit Agricole, and Credit Suisse have together written-down another $20 billion. (Societe Generale suffered additional losses of some $8 billion, incurred by a single rogue trader in the financial futures market.) The world’s stock markets, too, have become more global than ever. A decade ago, about 15 percent of the earnings of U.S. corporations arose from their international operations; by last year, non-U.S.

issue of Bloomberg Personal magazine, I describe the problem, using the famous Sherlock Holmes story about the slaying of a racehorse named Silver Blaze. Holmes noted “the curious incident of the dog in the nighttime,” curious because the dog didn’t bark. As a result of this insight, the canny detective realized that the culprit was the dog’s master. In the mutual fund industry, a majority of the fund directors are normally independent of the fund manager, and therefore nominally control the funds. But real control lies with the master of the funds—the fund manager. And history has shown that no matter what the master’s actions, the watchdog—a word almost universally used to describe the role of the independent director— simply doesn’t bark. If the fund manager is the culprit, what is the crime? For me, it is the change in the central ethic of the mutual fund industry from the profession of investing—the stewardship of shareholder assets—to the business of marketing—gathering assets, and creating whatever “products” it takes to do so. Five problems have resulted from this change: 1. Soaring Turnover Among Mutual Funds. Fifty years ago, most mutual funds held to prudent long-term investment objectives. Today, less than half of all equity funds, by my count, meet that standard. Increasingly created to capitalize on hot stock styles and hot money managers, mutual funds now come and go at an unparalleled rate.

Short-term fluctuations in the earnings of existing investments, he argued (correctly), would lead to unreasoning waves of optimistic and pessimistic sentiment. (Lord Keynes was ahead of his time!) While competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, should correct the vagaries caused by ignorant individuals, Keynes added, the energies and skills of the professional investor would also come to be largely concerned; not with making superior long-term forecasts of the probable yield of an investment over its whole life (enterprise), but with foreseeing changes in the conventional basis of valuation (speculation) a short time ahead of the general public.described

your founder’s tutelage, right then and there, in the City of Brotherly Love. I might easily have been that young man. It was just before Thanksgiving of 1945, shortly after the end of World War II, when this young resident of New Jersey first arrived in this fair city. That was a while ago. The Chinese Wall carried trains into Philadelphia, and Broad Street Station was the main railroad stop. My twin brother David, bless his soul, was with me, two sixteen year-old boys coming here for the first time on a bus from Blair Academy to celebrate the holiday with our parents. We were hardly wealthy. Our parents (my older brother William, then 18, was serving in the U.S. Marine Corps) lived in two rooms on the third floor of a home in Ardmore, but the space was enough for all of us—at least for the holidays. We ate our dinners at Horn and Hardart’s around the corner. When I was on vacation, I worked at the Ardmore Post Office, the first diamond, though I didn’t realize it at the time, in the truly vast mine that I had discovered here. All three Bogle boys were boarding students at Blair Academy in northwestern New Jersey—a God-given opportunity to begin a fine education. We earned scholarships and we waited on tables. A few years later, when our family resources were such that two of us had to go to work full time, I was the one who was fortunate enough to go to college.

Today I’m going to present to you graphic evidence of these trends, which, I fear, bode ill for this industry, and for the financial markets as well. While I have been speaking out on these trends for more than a decade now, they’ve only gotten worse. On the other hand, confession being good for the soul, I acknowledge that there is little evidence of their baneful effects on the stock market—so far at least. Protecting the Interests of Those Whose Funds They Command . . . Nonetheless, these trends—the focus on marketing, the soaring levels of fund investment activity, and the huge increase in fund expenses—could combine to engender, a year or two or three down the road, the kind of statement made in 1934 by Justice Harlan Fiske Stone as he reviewed the events that led to the Great Crash of 1929 and the Great Depression that followed. “When the history of the financial era which has just drawn to a close comes to be written, most of the mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that ‘a man cannot serve two masters’ . . . The development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to that principle if the modern world of business is to perform its proper function.

many ideas that don’t comport with at least my concept of common sense, and I urge you to disregard each one of them in direct proportion to its complexity, its decibel level, and the conviction of its advocates that a favorable outcome is assured. Avoid complex strategies that seem to provide temptingly easy solutions to eternally complex problems. I warn you that complexity—which I call “witchcraft”— may seem to offer a perfect plan, but it rarely delivers on the dream it promises. What is more, complexity is expensive. The simplicity of a good plan, on the other hand, can work not only effectively, but economically. The good plan works, not despite being inexpensive, but because it is inexpensive. Asset Allocation My remarks today will focus on equity mutual funds, but I want to begin with a brief word about asset allocation, for it is one of the most important investment decisions you make. While there are complex systems that offer precise formulas for implementing the perfect asset allocation plan, the good asset allocation plan simply assumes that these nuances of investing are unpredictable. The good plan relies primarily on a straightforward and conventional balance between stocks and bonds. How much in each category? As ever, your investment balance must depend largely on your own needs and circumstances.

The National Constitution Center While I’ve been a director of the National Constitution Center since its inception in 1988, in the early years I was a pretty poor example of that old family tenet, making little if any difference. But after a management upheaval in 1996—and with the return of my energy following a heart transplant earlier in the year—I became increasingly involved. Then-mayor Rendell and NCC president Joseph M. Torsella had brought this near-moribund project back to life, doing yeoman service in obtaining our splendid location on Independence Mall, supervising the architectural design, and raising the money for the building. Amid those efforts, late in 1999, they asked me if I’d be willing to succeed the mayor as chairman. I agreed to do so for six months, only until they could find what I described as a “real” chairman. But last October, I began my eighth year as Chairman, enjoying one of the great experiences of my long career. Chief executive Joseph M. Torsella, a young graduate of the University of Pennsylvania (and a Rhodes scholar) proved to be a renaissance man—entrepreneur, manager, planner, historian, and extraordinary human being. Under his leadership, the new museum came into being both on budget ($185 million, including a $40-million endowment) and on time, opening on schedule on July 4, 2003. Small wonder that early in 2004, project completed, Joe moved on to seek public office.

consumer products at one stage in their history, products to be heavily marketed until times and fashions change and then replaced by something else that is saltier or softer or sleeker. We would offer financial services, or simply stewardship, durable mutual funds with sound investment philosophies, prudent strategies implemented with simplicity, and rock-bottom costs to investors, the better to enhance their profits. The idea: We would not make what we could sell. We would sell what we made. Finally, we did not seek customers, those who would move from one product to another depending on fad or whim, location or price. We had no interest in creating an investment version of Poke’mon or the Barbie doll or the pet rock. Long-term investors, not short-term speculators, would be the focus of our strategy. We sought clients, those who would enter into a long-term investment relationship with us, trusting in our investment skills and our stewardship. That anecdote, I think, says a great deal about Vanguard’s view of the service-profit chain. While the chart in Harvard Business School Professor Michael Porter’s 1996 article, “What Is Strategy,” nicely describes how Vanguard works (Chart 1), my story explains why Vanguard works so well. In any event, for an enterprise that began without a single employee, or a single product, or even a single customer 25 years ago, we have come a long way.

federal, state, and local governments who collect taxes, not only on fund income but on excessive distributions of realized gains born of all of that rapid portfolio turnover. Revolutionary Words A change in the entire modus operandi of this industry is imperative. Yet it seems nowhere in sight. So I urge you at NAPFA to bring this much-needed change by pressing the mutual fund firms to which you entrust your clients’ assets to cut their costs. The litany of costs that I have just enumerated has added up to a serious diminution of fund returns during the long bull market. At least a quarter of the market’s annual returns—more than 4 percentage points per year—have gone to the croupiers. When market returns fall back to more normal levels—as they will—the diminution will be cataclysmic. Gentlemen*, you must recognize (1) that companies having the smallest expense will have the ultimate advantage; (2) that companies having this advantage are the most desirous of correcting present abuses, and (3) that companies which cannot long survive the present condition of affairs are determined to nullify every effort for reform. To save our business from ruin we must at once undertake a vigorous reform. To do this, the first step must be to reduce expenses. That is the message I bring to you today. Those words may sound rather idealistic and fiery—even revolutionary—so I quickly confess that they are neither new, nor mine.

diversification, and focus on the long term—to say nothing of being skeptical of stock-picking and market-forecasting wizards—would be an understatement. (Indeed, it’s pretty much what I wrote in my Princeton senior thesis in 1951.) What’s more, an entire chapter of my latest book2 is devoted to showing that, given the radical change in our investment environment during the past three decades, Ben Graham would have gone even further, and endorsed the stock market index fund as the core strategy for the vast majority of investors. (Warren Buffett, who worked closely with Ben Graham, not only personally assured me of Graham’s endorsement, but put it in writing in his endorsement of my new Little Book.) The fact is that, even when I entered the mutual fund industry 56 long years ago—hired by fund pioneer Walter Morgan, whose Wellington Fund was, and remains today, the paradigm of these sound principles—this industry invested pretty much in the way Graham prescribed. The portfolios of the major equity funds consisted largely of a diversified list of blue-chip stocks; and managers invested for the long-term, eschewed speculative operations, managed their funds at costs that were (by today’s standards) tiny, and delivered market-like returns to their investors. (As the record clearly shows, those fund managers were hardly “wizards in picking winners.”) What a difference a half-century makes! How different?

1. Faith in the Financial Markets I’m confident that few, if any, of you in this sophisticated audience have any doubt that we have moved into a new era for the financial markets. I expect that it will be an era in which the returns of stocks and bonds alike will be substantially lower than the unprecedented double-digit returns we’ve experienced in the past, indeed—unless you’ve put in more than two decades in this wonderful business—the very past that comprises your entire first-hand experience in the markets. And you need three decades to have known first-hand what the 50% market crash in 1973-74 was like. (This one’s now at 40%). Suffice it to say that it was almost exactly twenty-years ago—on August 18, 1982, in the aftermath of a nine-year bear market—that interest rates turned downward and stock prices leaped upward. The T-bill rate, 11% when August began, promptly tumbled to 8%. The Standard & Poor’s 500 Stock Composite Index leaped from 103 to 113 during that single week, and to 120 by month’s end, in the blink of an eye, a gain of 17%. We were on the way. In the great boom, which culminated with a great bubble in March 2000, the Index was to rise to 1527. By then, the annual return on stocks had reached a level unprecedented in any comparable period in history—just short of 20% per year. And the bond market, which earned a return of more than 10% annually over this long period, also performed far better than ever before.

on the balance sheets of individual investors for as far ahead as the mind can imagine. For America’s families have spoken, and mutual funds have emerged as their investment of choice to an astonishing—and often unrecognized—degree. Consider our nation’s historical savings flow patterns. As the 1970s turned to the 1980s, our families were investing about 20% of their capital in mutual funds. By the turn to the 1990s, the rate had risen to 25%. But by 1996 it had risen to 60%. And by the turn of the millennium, it had soared to 82%. Yes, on average during 1999-2001, our families—the very backbone of the U.S. economy—saved $385 billion per year . . . and placed $320 billion of it in mutual funds. No Longer an Equity Fund Industry This powerful increase in market penetration says something very simple about mutual funds: They are popular with investors who use them. But it also says something else: Today’s fund dominance comes because of the remarkable flexibility of the fund industry and the wide span of financial instruments that mutual funds comprehend. Lest we forget, this industry includes not only equity mutual funds (the apparent focus of the Forrester study), but bond funds and money market funds. When you think about it, mutual funds are the investment of choice in each asset class, and will continue to grow—no matter what the course of the financial markets, no matter what the emotional state of the American investor.

Despite that philosophy and despite my callow words to Forbes, within a year we took our first aggressive steps to expand our technology commitment. Bob DiStefano—then and now Vanguard’s technology boss, and for my money, one of the most capable technology executives in the financial services field—reminds me that in mid-1986 I urged him to step a bit more lightly on our cost-control brake and more heavily on the accelerator that drove our then-modest technology program. While the numbers seem puny by today’s standards, we quickly upped the number of programmers’ two-and-a-half fold—from 22 to 56—and our total tech staff to 75. We have been building our technology focus and commitment ever since. In those days, our world was fairly simple: each shareholder in each fund got a regular quarterly statement from each fund independently, just as if he or she owned, say, one Vanguard fund, one Fidelity fund, and one T. Rowe Price fund. With some 700,000 shareholders on our books—most of who owned but a single fund—that was “industry standard” at the time. But the standard was about to change, and our commitment to expand our technology effort came not a moment too soon. Our business not only grew by leaps and bounds, but at ever-increasing levels of activity and complexity. Today, with some eight million shareholders on our books, Vanguard has become the second largest mutual fund organization on the face of the globe.

Independence Hall. The Center opens on July 4, 2003, just 224 days from now. In all, I am proud to be among the “posterity” for whom our Founding Fathers “secured the Blessings of Liberty.” As infinitely grand as they are, however, the blessings I have received are hardly sufficient to explain the events that bring me to this podium today. Nor are the marvelous experiences that I have been privileged to enjoy, thanks to our Nation’s historical commitment to public education and then to the generosity of our forebears who have not only built private schools and colleges but have endowed scholarships for those less privileged who sought to advance their own learning. Nor can an adequate explanation be found in the still unremitting work ethic that was drummed into me by some combination of my genes, my upbringing, and that greatest inspiration of all, necessity. While that background may be necessary to explain my readiness when the lightning of opportunity strikes, it is not sufficient. For the reality of life is that great opportunity strikes but rarely. So never underrate luck as an essential merit in any career that turns out well! For me, at every opportunity—never so more that at three major turning points along the way—I’ve truly been luck-struck. Each time, an almost random event directed me into a new career. So I’m pleased to have this opportunity to tell you about “Three Lucky Breaks—Three Exciting Careers.

they may be, but perform them better than we have ever performed them before; improve our individual contributions to our enterprises, our organizations, our professions, our society; make our institutions strong in accomplishment and mission, and stronger above all in character. To use a phrase I’ve used a thousand times over in my firm over the years: In making this a stronger nation, we must Press On, Regardless.. But there is a second thing we must do. We must open our hearts to greater love than we have ever imagined: Hold our families even tighter; appreciate our colleagues even more; show our neighbors even more respect; and honor all of those whom we meet along the road of life, from the highest to the humblest, even with a single gesture or a simple kindness. That too will make America a better place. A recent article in The New Yorker made the same point, but with the memorable and distressing image that flashed across our television screens. Human beings tumbling to their death from the highest ledges of the towers, including two people jumping in tandem, hand in hand. Appalling and terrifying as it is, that image reminded Anthony Lane, the author of the article, of Philip Larkin’s poem about a pair of stone figures carved on an ancient English tomb. The poet wrote of the “sharp, tender shock” when he noticed that the figures of the earl and countess, “side by side, their faces blurred,” are holding hands.

The meeting turned on a single number. Ed Stead raised his hand, quieted the room, and asked what Netflix was thinking in terms of price. Chief financial officer Barry McCarthy began a rehearsed windup about recent comparable transactions, but Hastings, losing patience, interrupted and named the figure: fifty million dollars. McCarthy's hands fell into his lap. Randolph, watching Antioco throughout, saw the Blockbuster chief executive's earnest expression give way to a tiny, involuntary turning up at the corner of his mouth, and understood at once that Antioco was struggling not to laugh. The meeting went downhill quickly after that. On the long, quiet flight home, with the sandwich tray untouched, Randolph tapped a plastic spoon against an empty champagne flute and toasted the obvious conclusion: Blockbuster did not want them, so now they were going to have to kick Blockbuster's ass. As Randolph tells it, the rejection made survival entirely Netflix's own project, and the company resolved to be ruthless in its focus on the future.

Microsoft and Visa both appeared in this list last year and have been consistently amongst the best performing stocks since inception of the strategy. Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either. The bottom five were: Church & Dwight -0.7% 3M -0.3% Colgate-Palmolive 0.0% Clorox 0.0% Reckitt Benckiser +0.3% We switched the holding in Church & Dwight into another American consumer products company – Clorox – which produces a higher return on capital. We sold our stakes in 3M and Colgate Palmolive during the year. With 3M we were acting on growing doubts about the current management’s capital allocation decisions, and in the case of Colgate Palmolive we grew tired of waiting for an effective growth strategy to emerge. This year we have included the Sharpe and Sortino ratios for our Fund and the Index in the performance table on p.1. I realise that for those of you who are not investment professionals what I say next may well seem to be gobbledegook. However, whilst the returns which our Fund provides are very important so is the amount of risk assumed in producing those returns. These ratios attempt to measure that.

“In an uncertain world, tactical change should be made sparingly, and only if you are prepared to take the risk of being wrong.” In my book, I presented a basic asset allocation model that recommended that older investors, no longer adding to their assets with additional investments and becoming increasingly dependent on income, should focus on a 50/50 stock/bond allocation, reduced to 35% for investors over the age of 75. (No, I’m not there yet, even using my non-heart-transplant age!) Both model portfolios recommended that the equity position be composed of value funds and equity-income funds, to the exclusion of growth funds, although I have not followed this strategy myself. Instead, I’ve relied largely on broad-based index funds which weight value and growth equally. In any event, both the 50/50 and 35/65 equity-income and value-based portfolios actually rose 14% during 2000 and are now actually up another two percentage points so far this year. (Both had about the same returns.) We should all have been so lucky! I have no way of knowing how many of you followed my conservative advice, nor how many of you, lured by the boxcar gains turned in by growth funds and tech funds as the stock market reached its high a year ago, abandoned it at just the wrong time. But I believe that if you were guided by the “Twelve Pillars of Wisdom” that was the epilogue of my first book, you’ve done just fine.

Lynch used the 2019 Roundtable to make an argument he had been making privately since the 1990s — that the individual investor's edge over the professional is widest in the smallest, most boring segments of the market. Professional desks are paid to outperform benchmarks, which means their time is rationed toward names that move the benchmark. The smallest quintile of the Russell 2000 contains companies whose market caps are too small to move even a small-cap index, and whose analyst coverage is consequently thin or absent. Lynch's picks in 2019 sat in that segment — companies whose entire market cap was below a billion dollars, whose earnings were growing at double-digit rates, and whose management teams were personally buying stock in the open market. The picks illustrated the method rather than the result. Lynch's claim was not that any particular 2019 pick would compound at twenty percent; it was that the discipline of looking where the consensus is not looking produces, over a portfolio of such picks, an average return meaningfully above the index. The mathematics of an active small-cap portfolio is asymmetric: most picks do fine, a few do very well, and a few do badly; the winners pay for the losers because position sizing caps the downside at one times the cost and the upside is uncapped. Lynch's closing observation in the interview was that the worst mistake a retail investor can make in the current environment is to assume that the index fund has already found every mispricing. The index fund owns everything at market weight, which means it owns the under-priced names and the over-priced names in proportion to their market caps. The active investor who screens for the under-priced subset will outperform the index by definition, provided the screen is based on fundamentals rather than on momentum. The passive revolution has not eliminated mispricing; it has redirected the mispricing into the names that the index providers do not bother to look at.

How huge? A long-term investor who owns a portfolio of stocks of all of the companies in America, holds them for Warren Buffett’s favorite holding period—forever—and pays no management fee will!—will—end up with a financial stake that is at least double that of all other investors as a group. How to do that? Own an all-stock-market index fund. That now-pervasive idea began with the creation of the Vanguard 500 Index Fund more than 27 years ago. At first it was dubbed “Bogle’s Folly.” But today it is the largest mutual fund in the world. (Memo to young entrepreneurs: never worry about disdain for your ideas!) Energy and Persistence Low-costs and indexing are the simple rocks on which Vanguard was founded, an enterprise built on the majesty of simplicity in an empire of parsimony. So never underrate the power of common sense. Never underrate your ability to recognize the obvious, for, paradoxical as it may seem, the obvious is often the hardest thing to see. And then pursue your vision with energy and with persistence. Why? Because “energy and persistence conquer all things,” as that timeless epigram of Founding Father Benjamin Franklin reminds us. With all of his other talents, this great patriot also qualifies as the first American entrepreneur.

to set out on a new course that, paradoxically enough, will lead us directly back to where we began, with the traditional values of capitalism—trusting, and being trusted.” Let’s start with why you should—indeed must—care about our system of free-market capitalism. I argue that it is the job of every concerned citizen to “uphold the values that once made our corporate and financial enterprises so successful, fairly providing the rewards of investing to those who put up the capital and assume the risks involved. To win the battle to restore the soul of capitalism, it is these values that must prevail.” Why? Because, as I explain, “we require a powerful and equitable system of capital formation if our nation is to overcome the infinite, often seemingly intractable, challenges of our risk-fraught modern world. Our economic might, political freedom, military strength, social welfare, and even free religious values depend upon it.” “The Birth of Plenty” Why capitalism? Just think of what modern capitalism has done in its 200-odd years of existence. Quoting from William Bernstein’s fabulous book, The Birth of Plenty, up until the beginning of the nineteenth century “the improvement in human well-being was of a sort so slow and unreliable that it was not noticeable during the average person’s twenty-five-year life span . . .

Jack Treynor, William Fouse, and Paul Samuelson—that distinguished list of practitioners and academics known to you all—make their extraordinary contributions to the study of finance and investment. The Theory of Transaction Costs In Bachelier’s 70-page dissertation, he makes no reference to the role costs play in speculation and investment. But costs obviously matter. And costs matter not only in financial markets, but in all economic transactions. Yet it is only in the past year that much academic attention has been paid to transaction costs. Just a month ago, in a report on E-commerce, The New York Times described a paper on transaction costs entitled “The Nature of the Firm,” written way back in 1937, which resulted—but not until 1991—in a Nobel Prize in economics to Professor Ronald Coase of the University of Chicago Law School. In his paper, he showed that it was transaction costs (then prohibitively high) that should determine whether or not a company should produce goods or services on its own, or farm them out to suppliers. Similarly, a recent paper by Professors Maurice Obstfeld of the University of California at Berkley and Kenneth Rogoff of Harvard has gained important attention.

funds, including both fully disclosed (if often ignored) direct expenses—used for operating, marketing, and investment advisory costs plus generous profits for the managers—together with the hidden costs of fund portfolio transactions, the net rate of return of funds as a group, and, over the long run, of individual funds, has tended to lag the market by about 1-1/2 to 2-1/2 percentage points annually. To save you the trouble of pulling out your calculators (or slide rules!), a long-term return of, say, 10% without costs will provide, over 40 years, a terminal value of twice as much as a return that incurs annual costs of 2% and thus provides a net return of 8%. Costs consume 20% of the return—and that’s expensive. Exhibit I, simply a basic compound interest table, graphically contrasts the relative accumulations over time under these two return assumptions showing that $10,000 at a 10% return grows to $450,000 over 40 years, more than double the $220,000 it reaches at an 8% return. Superficially small differences in annual returns, extended over long periods of time, will make a dramatic difference in the final capital in your retirement fund. 1. RTM in Mutual Fund Returns In periods as short as one year, many mutual funds—especially small, aggressive ones—can and do defy these odds. And in some decade-long periods, perhaps one out of five funds succeeds in doing so by a material amount.

The founders misjudged the jump from books to electronics, Binny conceded. They assumed high-ticket gadgets would behave operationally like paperbacks, but buyers of phones and laptops were far more risk-averse about delivery and returns. The mistake forced Flipkart to rebuild its post-purchase experience, incentives and trust signals for each new vertical.

To have such a crew, we’ve relied heavily on traditions—some venerable, such as a spirit of fair-dealing dating back to Wellington and Walter L. Morgan, others going back to the earliest days of Vanguard, such as our Award for Excellence and the Vanguard Partnership Plan. Yes, “even one person can make a difference,” and yes, each crew member has earned the right to share in the fruits of our success. Taken together, our structure-driven corporate strategy, our innovative investment ideas, and our progressive implementation of business values have made Vanguard an industry revolutionary: A company that stands for something. And the world knows what it is we stand for: The primacy of the shareholder. Stewardship. With the power of an idea we have flourished. I know no other firm in this industry about which that can be said with such crystal clarity. What of the future? “The times they are a changin.” What does a revolutionary firm do? Live off the legacy I have put my heart and soul into giving you, or build on the legacy? The answer to that question, ladies and gentleman, is in your hands, no longer in mine. But as you make these decisions, please remember that we will be judged not only by what we do but what we refrain from doing. Opportunity yes, but discipline too. And confidence. And courage, always.

The more things change, it seems, the more they remain the same. If the issue were simply “did the adviser outpace the market?” over the decade, the answer is clear. Most advisers did not. Indeed, as a matter of simple mathematics and elementary logic, most advisers cannot outpace the market. And it is only fair that advisers should fully disclose not only the absolute rates of return they have achieved—in interim periods and over the long term—but how those returns have compared to the returns that would have been achieved by an appropriate benchmark standard accepted by manager and client alike as a prime measure of success over the long pull. But we have long since passed that basic point of departure. Now we see a powerful focus on quarterly relative performance. And the performance is invariably related to a single, omnipresent “bogey” (a Scottish word meaning “goblin,” and few advisers regard it in kinder terms), the redoubtable S&P 500 Stock Index.1 What is more, we often see weekly comparisons, and even daily comparisons—after a significant market drop but, curiously, rarely after a sharp rally. “Having gone up less for all those years,” the client asks his fund manager, “did you go down less when the market dropped 554 points a few Mondays ago?

A decade later, at the beginning of 1982, the little guy had grown a bit (to $125 billion), but not much faster than his big NYSE brother ($1.1 trillion), and equaled 11% of the value of all listed stocks. And even a decade after that, the NASDAQ’s $500 billion market capitalization in 1991 still represented but 13% of the NYSE’s by-then-$3.7 trillion. And even seven years after that, the NASDAQ value ratio had risen to a still modest 18% of the NYSE—$1.7 trillion vs. $9.4 trillion as 1998 began. But the staggering $10 trillion combined increase in the value of the indexes since 1981—from $1.2 trillion to $11.1 trillion—makes an obvious point: U.S. investors were in the midst of one of the greatest bull markets of all time. Surely, we had never had it so good. And then, in this Tale of Two Markets, a great chasm opened between the NASDAQ and the NYSE. In 1998, NASDAQ Index +41%; NYSE Index +19%.1 In 1999, +87% vs. +11%. And in 2000, through March 10, the NASDAQ rose another 24%, while the NYSE Index actually declined, by 7%. With the NYSE up but 21% in the face of the 230% leap in the NASDAQ, the market capitalization of NASDAQ had leaped to $6.8 trillion, fully 60% of the $11.3 trillion market cap of the NYSE, compared to 25%, plus or minus, during the prior two decades.

and contentious start arose one of the most important and powerful investment ideas of the age, an age whose anniversary we celebrate at this Sixth Annual Superbowl of Indexing. Two Schools of Indexing—Quantitative and Pragmatic I think it’s fair to say that there were two principal schools of index development. I’ll call one the Quantitative School—the masters of mathematics led by Harry Markowitz, William F. Sharpe, and the Wells Fargo Financial Analysis Department, who reached their conclusions after doing complex equations and conducting exhaustive research on the financial markets. Princeton’s Burton Malkiel also deserves a share of the credit. In 1973, in the first edition of his persuasive and ever-popular A Random Walk Down Wall Street, he endorsed the efficient market hypothesis and called for a no-load, low-fee mutual fund that simply buys the market and does no trading. In essence, the Modern Portfolio Theory developed by the Quantitative School proved that a fully-diversified, unmanaged equity portfolio was the surest route to investment success. While the Quantitative School developed its profound theories, what I’ll call the Pragmatic School simply looked at the evidence. Dr. Paul A.

as far as I can recall, was to move on with my life, to do the best I could, and to earn a good living. But in an extraordinary stroke of luck, I had written my undergraduate thesis on the then “tiny but contentious” mutual fund industry. Through the thesis, Walter L. Morgan, the founder of one of the industry’s finest firms, gave me my first break, hiring me and then becoming my mentor. That was a half-century ago, but as I re-read my thesis preparatory to its publication in my forthcoming book I realized that even then I had a powerful sense of idealism that even a half-century of experience has been unable to diminish. Indeed, I have little doubt that my idealism today is stronger than it’s ever been. Even back in 1951, I urged that mutual funds serve—“serve the needs of both individual and institutional investors,” and serve them “in the most efficient, honest, and economical way possible . . . with a reduction in sales loads and management fees . . . minimizing investor misconceptions . . . and claiming no superiority over the stock market averages.” As it has turned out, in those broad brushstrokes lay the core idea of the firm I would found in 1974: The soundest way to participate in the long-term growth of our nation is simply to own the stocks of all of the businesses in America, to own them at rock- bottom agency costs, and to hold them forever. (We apply that same concept to all segments of the financial markets.)

of the Roman Empire, I warn, “that no nation can take its greatness for granted . . . For America to sustain her economic strength, her national power, and her global leadership, our nation’s vast business financial complex” must function with optimum effectiveness. My clear conclusion is that we are not doing so, in large measure because capitalism has changed, and for the worse. It is a curious fact that my new book echoes in so many ways the very principles set forth in my Princeton senior thesis, which focused on the need to put fund shareowners at the top of the investment food chain. That thesis—and all that followed—depended on an incredible stroke of luck. In Firestone Library almost 56 years ago (though it seems like only yesterday), I happened upon the December 1949 issue of Fortune magazine and learned for the first time that something called “the mutual fund industry” existed. When I saw the industry described in the article as “tiny but contentious,” I knew immediately that I had found my thesis topic. Completed in the spring of 1951, it was entitled “The Economic Role of the Investment Company.” Read today, my thesis would probably impress you as no more than workmanlike, perhaps a bit callow, but above all, shamelessly idealistic. On page after page, my youthful idealism speaks out, calling again and again for the primacy of the interests of the owners of mutual fund shares. The prime responsibility (of fund managers) must always be to their shareholders.

A central narrative of the book is the closing of the Medallion Fund to outside capital in 1993 and again in the mid-2000s. Zuckerman frames this as the rare decision in finance to cap assets in order to preserve returns, against the conventional incentive to grow assets under management and thus grow fees. The decision was a direct consequence of the firm's own research. The signals Medallion exploited had limited capacity: betting too much against an inefficiency destroys the inefficiency, and the firm's researchers had measured how quickly returns decayed as capital scaled. The honest conclusion was that the strategy could absorb only a few billion dollars before its own weight would compress the edge. Most hedge funds respond to that finding by launching new products that replicate the strategy for outside capital at lower fees. RenTech eventually did exactly that with the Institutional funds, but with Medallion itself the firm chose instead to internalize the capacity - to limit participation to employees and a small set of long-standing investors, and to return outside capital. The compounding consequence, over decades, was that the returns accrued to a small group rather than to a broad investor base. The decision to cap the fund was, in retrospect, one of the most valuable choices in the history of institutional investing.

Bloomberg estimated Zhang's net worth at $92.8 billion as of June 2026, and Wikipedia states the global popularity of TikTok made him the richest man in China in 2024.

up to yesterday afternoon, when a shareholder on my flight down here from Philadelphia asked me why, in view of my reputation for thrift, I was flying in the first-class section. (The answer, I told her, was that I got a free step-up with my frequent flyer miles. But she didn’t seem satisfied. I think, truth told, that she shouldn’t have been!) The root causes of the disease in our system are deep, and the remedies that are required to cure it will not be easy to come by. For what we have witnessed in the failure of corporate governance in America has been, as journalist William Pfaff described it, “a pathological mutation in capitalism.” He was right on the mark. The classic system—owners capitalism—had been based on a dedication to serving the interests of the corporation’s owners, maximizing the return on their capital investment. But a new system developed—managers capitalism—in which “the corporation came to be run to profit its managers, in complicity if not conspiracy with accountants and the managers of other corporations.” Why did it happen? “Because,” in Mr. Pfaff’s words, “the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.

Perhaps the delay in the recognition of Franklin’s entrepreneurial talent has arisen from a misunderstanding of what entrepreneurship is all about. While in today’s grand era of capitalism the word “entrepreneur” has come to be commonly associated with those who are motivated to create new enterprises largely by the desire for personal wealth or even greed, the fact is that entrepreneur (leaving aside its archaic meaning of “the manager of a public musical institution”) simply means “one who undertakes an enterprise,” a person who founds and directs an organization. At its best, entrepreneurship entails something far more important than mere money. But do not take my word for it. Heed the words of the great Joseph Schumpeter, the first economist to recognize entrepreneurship as the vital force that drives economic growth. In his The Theory of Economic Development, written nearly a century ago, Schumpeter dismissed material and monetary gain as the prime mover of the entrepreneur, finding motivations like these to be far more powerful: (1) “The joy of creating, of getting things done, of simply exercising one’s energy and ingenuity,” and (2) “The will to conquer: the impulse to fight, . . . to succeed for the sake, not of the fruits of success, but of success itself.” Money—A Means to An End There is a difference, then, between an entrepreneur and a capitalist. According to biographer H.W.

topic for my senior thesis, then as now, a requirement for the Bachelor of Arts degree at Princeton. Chart – Total Mutual Fund Assets, 1952-2003 Over the next 18 months, I spent countless hours researching and writing my thesis. Remarkably little public information was available about this field, then consisting of some 130 mutual funds with assets aggregating just $2½ billion. Harvard strategy guru Michael Porter advises people considering their careers to "pick a good industry," and I certainly did that when I chose my thesis topic. With an annual growth rate of almost 16% since then, the fund industry just may have been the fastest growing business in America, and today there are 9,000 funds, with total assets that approach $7 trillion! An Idealistic Senior Thesis Read today, my thesis would probably impress you as no more than workmanlike, perhaps a bit callow, but above all, shamelessly idealistic. (And you can read it, for two years ago it was published by McGraw-Hill, part of John Bogle on Investing: The First 50 Years; my "Press On Regardless" speech appears as Chapter 25. If you wait a half- century, perhaps anything can be published!) On page after page, my youthful idealism speaks out, calling again and again for the primacy of the interests of the mutual fund shareholder. At the very opening of my thesis, I get right to the point: Mutual funds must not "in any way subordinate the interests of their shareholders to other economic roles.

The great paradox of this remarkable age is that the more complex the world around us becomes, the more simplicity we must seek in order to realize our financial goals. Please underrate neither the majesty of simplicity nor its proven effectiveness as a long-term strategy for productive investing. Simplicity is the master key to financial success. The old Shaker ballad got it just right: "Tis the gift to be simple; Tis the gift to be free; Tis the gift to come down; Where we ought to be." This morning let me give you some ideas that should help you "to come down where you ought to be" in your quest for investment success. Given both the nervousness you doubtless felt in last summer's sharp stock market decline, and the excitement you likely felt in the splendid fourth quarter, I want to begin by reaffIrming four fundamental investment principles-four principles designed to keep you from the dangerous practice of acting on those emotions. First principle: Balance. The simple idea that investors should balance their stock holdings with bond holdings was drummed into me by the dean of the mutual fund industry, Walter L. Morgan, who founded Wellington Fund in 1928 and lived to see it become America's largest balanced fund. The recent death, at age 100, of my hero, my mentor who gave me the job that began my mutual fund career in 1951, and my great friend for nearly half a century(!) was heart-breaking for me.

It is hardly necessary to draw a chart showing the parabolic arc that reflected this explosion in the prices of NASDAQ stocks to draw the obvious conclusion: We were experiencing a bubble of historic proportions. 1 The NYSE Index and the NASDAQ Index are mutually exclusive; stocks are either listed or unlisted. It is therefore curious that the comparison of the two is so rarely made. Rather, the customary comparison is NASDAQ vs. the S&P 500, or vs. the Dow Jones Industrial Average, both of which include NASDAQ stocks. For example, at the March 2000 high, NASDAQ stocks represented some 25% of the S&P and 15% of the Dow. Market Capitalization: Nasdaq vs.Year-end

It “proves our almost-instinct, almost true: What will survive of us is love.” On first impression, that seemed to me to be a simplistic banality. But the more I considered the poet’s words, the more I was certain that they expressed an eternal truth. So tonight I want to speak to you about love. Not about love of family nor love of career, nor love of colleagues, nor even love of our fellow man, but love of community, and how we might go about expressing that love. Giving in Spirit Before I get to that subject, however, I want to address for a moment giving as a spiritual matter. I begin with Deuteronomy: Then say in thine heart, “my power and the might of mine hand hath gotten me this wealth.” But it is the Lord thy God that gaveth the power to get wealth that He may establish His covenant. Then add St.as

This investment strategy, at once innovative and counterintuitive, in turn depends on our unique corporate structure. We are a mutual enterprise owned not by the fund managers, but by the fund owners, an enterprise in which service to shareholders and stewardship are our highest priorities. With that combination of investment ideas and human values, we have striven to become one of those all-too-rare enterprises: A company that stands for something. We stand for the primacy of the fund shareholder. And it works! Vanguard’s growth is, to me at least, living proof that enlightened idealism is sound economics. Business: An Honorable Career Over the past half century, business has come to be my personal calling. But I’m not here to talk about my life and career. I’m here to urge you to think about your calling as you go out into the wide, wide world of business, whether it be commerce or industry, finance or technology. I urge you to fulfill your own personal destiny, to gain a sense of contributing something wonderful—perhaps unique—to society, something that you’re good at, something you enjoy, something that without you would simply not be there.

Zuckerman is candid that the firm's path was not linear. Early models, including a currency-trading effort in the late 1980s, broke down when the regime changed. The team learned that strategies built on a few years of data tended to fail when macroeconomic conditions shifted, and that the only durable signals were those that survived across multiple regimes. The book describes how this finding reshaped the research process. Rather than fitting a model to recent data, the firm demanded that a signal be explainable, that it survive out-of-sample testing, and that it not depend on a single historical episode. A signal that worked only during the 1987 crash, for example, was treated as overfit even if its backtest looked extraordinary. The deeper lesson was that overfitting is the central failure mode of quantitative research. A model that fits the past perfectly is, almost by definition, a model that has learned noise rather than signal. The firm's insistence on parsimony - on signals that could be explained, justified, and tested independently - was the discipline that kept its edge from being an artifact of curve-fitting. The repeated experience of finding that an apparently robust signal had been overfit trained the research culture to be suspicious of elegance and to prefer the ugly-but-durable.

I could think of no finer tribute to him than to reiterate the dedication to master architect Christopher Wren, in London’s St. Paul’s Cathedral, circa 1711: “If you would see his monument, look around.” Now, an outside chairman deserves only so much credit—and surely not too much—for the accomplishments of an institution. But hiring Richard M. (“Rick”) Stengel, a Princeton graduate (and a Rhodes Scholar, too) as Joe’s successor proved to be a providential decision. Again, I did my best to support Rick, who also proved to have remarkable entrepreneurial and leadership talents. In 2006, when Rick was lured back to lead TIME magazine as its managing editor, I was devastated but understanding. But in a moment of inspiration, I quickly called Joe. Within 48 hours he’d agreed to return to the Constitution Center. I revel in his continued leadership there, second time around. Later in 2006, when I decided to relinquish my chairmanship, I turned the job over to former President George H. W. Bush. Surely it’s no mean honor to succeed a mayor who became a governor, and a similar honor to be succeeded by a president! While I received many accolades as my near-eight year stint at the Center came to an end, my biggest contribution was the simple recognition of the extraordinary talents of the two chief executives with whom I served. I supported them unstintingly, and advised them whenever they asked.our

the market as “. . . a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.” In my 1951 Princeton senior thesis on the mutual fund industry, I cited Keynes’ conclusions. And this callow young kid had the temerity to disagree with the great man. Rather than professional investors succumbing to the speculative psychology of ignorant market participants, I argued, these investment professionals would focus on enterprise. In what I predicted—accurately, as it turned out—would become a far larger mutual fund industry, our portfolio managers would “supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic [italics added], a demand that is based essentially on the [intrinsic] performance of the corporation rather than the public appraisal reflected in the price of its shares.” Today, while the now-$12-trillion mutual fund industry holds some 35 percent of the shares of just about every public corporation in the land, the industry’s focus on speculation has actually increased many times over. Alas, the steady, sophisticated, enlightened, and analytic focus on enterprise that I had predicted from the industry’s expert professional investors has failed abjectly to materialize. I was wrong. Call the score, Keynes 1, Bogle 0. What else is new?

” There was a timely convergence of human and physical capital, supported by a network of modern systems: legal, financial, commercial, educational, governmental, and the like. Result:. Then, two centuries ago, and the modern world was born the world’s standard of living began inexorably to improve. Over the next 200 years, global living standards would rise by about 2 percent per year, increasing our worldly wealth from a mere $700 per capita to $6,000 in real terms, nearly nine times over. (Never underestimate the power of compound interest!) While capitalism has bestowed those economic blessings unevenly, it has bestowed them liberally, as living standards have risen all over the industrialized world. Those blessings are now spreading through the emerging economies of South America and Southeast Asia, including India and China, whose economy will surpass even America’s powerful economic engine within the next two decades.

In preparation for these remarks, I read them once again, and I found virtually nothing I would change today. Indeed, these twelve sensible guidelines to successful investing are lessons that investors should have learned before the bear market arrived, but that many are only learning now.65%

In December 1949, I happened upon an article in Fortune magazine (“Big Money in Boston”) on the then tiny mutual fund industry, and decided on the spot to write my Princeton senior thesis on mutual funds. Walter L. Morgan, founder of Wellington Fund, read it, and gave me the first break of my incipient business career: he hired me. That’s where it all began. So, let’s mark luck—which I’ll dignify by calling opportunity—as an unrecognized attribute of leadership. But it is critical to be ready when opportunity knocks. And, when it did, we had a plan. As a result, today we are the second largest mutual fund firm in the world, and first both in long- term growth rate and in current inflow of investor dollars. How? Because when opportunity knocked at the outset, we posited, accurately as it turned out, a coming age of rising family incomes, financial savvy, and investor education. And so we set out to provide investors with the very best value that we could. Such a strategy would require exceptionally low operating costs and the elimination of sales commissions.lowest

But Wellington's success-and his long life-serve as a testament to the durability of his investment principles. The bear market of last summer---one of only three 20+ percent drops in the past 20 years-has been reversed with a 25 percent gain that has now taken the market to newall-time highs. Surely we've never had it so good! But these spasms themselves remind us of something vital to recognize. The second principle: Markets Fluctuate. Many mutual fund investors seem to forget that fundamental reality. When stocks tumble, they push the proverbial panic button. Net cash flow into equity mutual funds, previously running at $18 billion a month, turned negative in August, with outflows of $11 billion, the first month of outflow since 1990. Those billions missed the recovery-and even at the lower stock prices of August and September, fund investors continued to pull money out of stock funds, albeit in smaller amounts.began

” And the deal must be fair: “there is some indication that costs are too high,” and that “future industry growth can be maximized by concentration on a reduction of sales charges and management fees.” After analyzing fund performance, I concluded that “funds can make no claim to superiority over the market averages,” perhaps an early harbinger of my decision to create, nearly a quarter-century later, that world’s first index mutual fund. And my conclusion powerfully reaffirmed the ideals that I hold to this day: The role of the mutual fund is to serve—“to serve the needs of both individual and institutional investors . . . to serve them in the most efficient, honest, and economical way possible . . . The principal function of investment companies is the management of their investment portfolios. Everything else is incidental.” All of this gratuitous advice from a callow college senior was, alas, largely ignored by the fund industry. But the creation of Vanguard in 1974 as a truly mutual mutual fund group— operated on an “at cost” basis for the benefit of its owners rather than its managers—was my attempt to walk the walk that I had talked the talk about a quarter-century earlier.assure

Samuelson’s 1974 article Challenge to Judgment noted the incontrovertible brute fact that academics had been unable to identify any consistently excellent investment managers, challenged those who disagreed to produce “brute evidence to the contrary,” and pleaded for someone, somewhere to start an index fund. And in 1975 in an article entitled The Loser’s Game, Charles D. Ellis argued that, because of fees and transaction costs, 85% of pension accounts had underperformed the stock market. “If you can’t beat the market, you should certainly consider joining it,” Ellis concluded. “An index fund is one way.” In mid-1975, when I decided to start the Vanguard index fund, I was both blissfully unaware of the work the quants were doing and profoundly inspired by the pragmatism of Samuelson and Ellis. It was then that I pulled out all of my annual Weisenberger Investment Companies manuals, calculated by hand the average annual returns earned by equity mutual funds over the previous 30 years, and compared them to the returns of the Standard & Poor’s 500 Stock Index. Annual Returns, 1945-1975: S&P Index 11.3%; average equity fund, 9.8%. To give that seemingly small percentage difference a high impact, I then showed that a hypothetical initial investment of $1,000,000 would have grown over the 30-year period to $25,000,000 in the Index vs. $16,500,000 in the average fund.and

For example: A U.S. President who says, “No Congress ever assembled, on surveying the State of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquillity and contentment . . . and the highest record of years of prosperity.” (Calvin Coolidge, December 4, 1928.) A financial article states, “the establishment of mutual funds by banks and independent groups has almost become a fad. The public appetite for them grows even more rapidly than the funds can. They represent buying power in the market that appears to be without a saturation point.” (“New Levels in the Stock Market,” August 1929.)

“As a result,” he wrote shortly after my graduation, “we have added Mr. Bogle to our Wellington Organization.” By age 36, I had become head of the company, entered into an unwise merger, and eight years later, was fired. (Yes, I was!) But even then, providence moved. Fired With Enthusiasm For what else but providence could possibly explain how when that door closed (more accurately, it slammed), a window of opportunity opened. Being fired—and with enthusiasm at that—gave me a providential opportunity to create a new and, I passionately believed, a better form of mutual fund organization, one truly mutual in its structure and governance.with

As I observe the changing world of information technology, with all its glamour, excitement, gadgetry, and drudgery, and the truly staggering allocation of the resources of financial intermediaries that are now devoted to it, I’d like to step back and ask the only question that really needs to be asked: Does the marriage of information technology and investing help 0.5 1.0 1.5 2.0 2.5 3.0 3.2001

For example, equity mutual funds incur corporate expenses— largely payments to the funds’ managers—that average about 100 basis points, a levy likely to cut the returns their investors earn by 10% or more over time.” In analyzing these factors in the mutual fund industry, we chose balanced mutual funds, since their asset allocation patterns are similar to those of pension funds—usually about 60%-65% in common stocks. Our results, based on the ten years ended December 31, 1996, clearly reaffirmed the BHB studies, with 88.7% of the variation in the balanced fund quarterly returns explained by asset allocation.shows:

Business Week described “a free-form financial corporation offering a complete line of financial services—worldwide. . . that may shake the entire industry.” The fledgling Institutional Investor magazine ran a cover story entitled “The Whiz Kids Take Over at Wellington.” We started off with a bang, and by the time 1967 was over, Ivest Fund was to have the best five- year record in the fund industry. But this was the “Go-Go Era” on Wall Street, which, as it turned out, was on the verge of collapse. What is more, the new investment group proved a painful disappointment. My determination to move quickly, my naiveté, and my eagerness to ignore the clear lessons of history had led me into a serious lapse of judgment. My error had resulted in failure—but just maybe reflected the attributes of a budding entrepreneur. In a sense, of course, life is often fair. I made a big error and I paid a high price. With the bust of the Go-Go Era in 1968, and then the terrible 1973-1974 bear market (down 50% from high to low; yes, it could happen again), the bloom was off the rose.had

chief executives—which last year averaged something like $7½ million annually, or 200 times the earnings of the average worker—is stunning, how about paying $257 million per year to the management company (other fees go to the distributor and the administrator) of a money market fund, a fund that inevitably underperformed its peers by the precise amount of its excess fees? How about paying some $3.6 billion(!) over the past decade to the management of an equity mutual fund that was promoted heavily, and grew so large as to become a closet index fund, but in fact fell short of the Standard & Poor’s Index by more than twice the costs it incurred? Surely nowhere has the triumph of Managers Capitalism been more obvious than in the money management field, where substantial waste of corporate assets is taking place right before our eyes. While the governance models of both corporate America and mutual fund America have the same flaw, however, the remedies to deal with the fundamental causes of the systemic failures we have observed in both areas are quite different. If that handful of giant institutional owners merely acts to bring corporate America back to its roots, it will happen, and happen relatively quickly.

We measure the economics of equity ownership by what I call investment return, the dividend yield on stocks plus the annual rate of earnings growth that stocks achieve. We measure the emotions of equity ownership by the change in the price that investors are willing to pay for each dollar of earnings (the P/E ratio)—what I call speculative return. Added together, these two returns produce the total market return. In 1983, for example, the starting dividend yield on the Standard & Poor’s 500 Stock Index was 5% and its earnings growth was 11%, an investment $53.07 $0 $10 $20 $30 $40 $50 $60 1975 1979 1983 1987 1991 1995 1999 '11/01 Nasdaq NYSE Growth of $1: Nasdaq vs. NYSE 3/00 $34.74 $31.07 $21.11/01

Technology, Binny argued, was Flipkart's actual operating system — embedded not only in the storefront but in pricing, marketing and supply-chain logic. He defended the choice on scaling grounds: without a coded system a problem solved manually once cannot be solved a thousand times, which in turn makes technology investment a precondition for, rather than a reward of, scale.

Their prime responsibility must always be to their shareholders." (Important advice that the industry seems to have ignored in the recent scandals.) Shortly thereafter, "there is some indication that costs are too high," and that "future industry growth can be maximized by concentration on a reduction of sales charges and management fees." (My advice fell upon deaf ears there as well!) After analyzing mutual fund performance, I conclude that "funds can make no claim to superiority over the market averages," perhaps an early harbinger of my decision to create, nearly a quarter-century later, the world's first index mutual fund. Still later in the thesis, "fund influence on corporate policy . . . should always be in the best interest of shareholders, not the special interests of the fund's managers." (Again, my advice fell by the wayside, and shareholders remain ill-served by the passive governance policies of most funds.) My conclusion powerfully reaffirmed the ideals that I hold to this day: The role of the mutual fund is to serve—"to serve the needs of both individual and institutional investors . . . to serve them in the most efficient, honest, and economical way possible . . . The principal function of investment companies is the management of their investment portfolios. Everything else is incidental."

Yet those who serve nominally as trustees, but relieved, by clever legal devices, from the obligation to protect whose who interests they purport to represent . . . consider only last the interests of those whose funds they command, suggest how far we have ignored the necessary implications of that principle.”1 In this industry, then as now, small groups “control the resources of great numbers of investors,” and it is fund managers who must accept the lion’s share of the responsibilities for the baneful trends I will discuss today. But fund directors—“those who serve nominally as 1 I last used that quotation in my “State of the Firm” address to the officers of Wellington Management Company in 1971, more than three years before I founded Vanguard. I was reflecting on the harm the fund industry inflicted on investors during the “Go-Go Era” of the 1960s, the precursor of the devastating 50% market crash of 1973-74.

Booming Markets, but Lagging Alphas How can it be that professionally managed mutual funds have failed to match unmanaged market averages? Simply put, it can be because it must be. Because mutual fund managers as a group are the market, and simply must, over the long run, underperfonn appropriately weighted market indexes by the amount of their costs. And their costs are large-and growing. Fund expense ratios have been rising for decades, and equity fund annual expenses now average more than 1.5% of assets. Fund portfolio turnover rates have also soared, presently running near 90% per year, with a consequent escalation in transaction costs, perhaps-although they are difficult to measure with precision-adding another 0.6% to the "fiscal drag" against an equity market in which frictional costs, in the abstract, do not exist. ("The market" as such has no advisory fees and no turnover.) That's a total expected annual shortfall of 2.1 % per year for fund returns. This shortfall-engendered importantly by costs-doesn't look like much when subtracted from a market providing a 30% annualized return-and, in fairness, probably wouldn't look like much if returns were, God forbid, "only" 20%. But, over time, it consumes fully one-fifth of a 10% return-to say nothing of confiscating four-tenths of a 5% return. Consider "Alpha," that vital measure of a fund's return relative to the stock market, adjusted to reflect the relative risk assumed by the fund.Funds

Stepped down as CEO of ByteDance on November 4, 2021, completing a handover announced in May 2021, while remaining chairman.

” The oddly and narrowly constructed Dow Jones Industrial Average, of course, remains our basic measure of daily market swings, though the market-value-weighted S&P 500 is equally invariably used when the time comes to make relative return comparisons over longer periods. Today, just as institutional pension officers scowl over their bifocals as they review the quarterly performance comparisons in regular meetings with their investment advisers, so individual investors receive the data each quarter, either in real time on their computers, or as late (shocking!) as the next morning’s newspaper. It seems dubious in the extreme that such short-term focus can be other than counterproductive. I should point out that these rat-a-tat volleys of comparative information are of relatively recent vintage. Indeed, mutual fund sponsors were prohibited by the Statement of Policy of the NASD from publishing “total returns”—even without making comparisons—from 1950 through 1 In fact, I must confess to being amused by the irony that the “bogle” is in fact the earliest-known goblin, already part of Scottish literature in 1500. (Some years ago, I was called “Beta Bogle, the data devil.”) Given my role in forming the first index mutual fund in 1975, it is not without possibility that active managers place me in the goblin category.

Brands,1 had Franklin possessed the soul of a true capitalist, “he would have devoted the time he saved from printing to making money somewhere else.” But he did not. For Franklin, the getting of money was always a means to an end, not the end in itself. “During the years when his (printing business) had to be established and placed on a sound footing,” Brands reports, “no one worked harder.” But the other enterprises he created as well as his inventions were designed for the public weal, not for personal profit. When he reminded us that “energy and persistence conquer all things,” Franklin was likely describing his own motivations to create and to succeed. Today, as we move into the twenty-first century, I’d like to talk to you about three areas in which Dr. Franklin’s idealistic eighteenth-century version of entrepreneurship should continue to inspire us. First, the application of his relentless energy and persistence to the service of the community’s greater good. Second, his invention—largely through trial and error and common 1 Benjamin Franklin—The First American, Doubleday, 2001.

” That transmogrification—that grotesque transformation—of a system of owners capitalism into a system of managers capitalism required only two ingredients: (1) the diffusion of corporate ownership among a large number of investors, none holding a controlling share of the voting power; and (2) the unwillingness of the agents of the owners—the boards of directors—to honor their responsibility to serve, above all else, the interests of their principals— the shareowners themselves. When most owners either don’t or won’t or can’t stand up for their rights, and when directors lose sight of whom they represent, the resulting power vacuum quickly gets filled by corporate managers, living proof that Spinoza was right when he told us, “nature abhors a vacuum.” Put more harshly, in a quote that I came across last month, “when we have strong managers, weak directors, co-opted accountants, and passive owners, don’t be surprised when the looting begins.” Of course the actual looting we know about has been small.to

Education, Enlightenment, Democracy, Capitalism The most important forces leading to the remarkable development of the world during the past millennium, it seems to me, have resulted from a combination of man’s education, enlightenment, and determination to seek new frontiers; the rise of democratic government; and harnessing the power of capital—human, financial, and corporate. As it was essentially described in The Wealth of Nations by that remarkable 18th Century Scot Adam Smith, capitalism was the linkage of the invisible hand of competition, individualism, and capital to create economic value. But to me, his preceding book, The Theory of Moral Sentiments, was at least equally important, for it is there that Smith argued, It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbitrator of our conduct. . .who shows us the propriety of reining in the greatest interests of our own for the greater interest of others, the love of what is honorable and noble, of the dignity of our own characters. For Adam Smith, the worldly philosopher, the creation of wealth depended on the goodness of man. I imagine that few other businessmen share my perspective on Adam Smith.of

But in the very long run, there is a profound tendency for the returns of high- performing funds to come down to earth, and, just as inevitably, for the returns of low-performing funds to come “up to earth,” as it were. Indeed, as I shall now show, the distance traveled in the course of these descents and ascents is directly proportional to the earlier distance above or below the market’s return. In short: reversion to the market mean is the dominant factor in long-term mutual fund returns. Let’s begin with an example. I have selected the past two full decades to perform this test: the 1970s (which provided uncharacteristically modest equity returns) and the 1980s (which returned the favor by providing unusually generous returns—a sort of RTM example in a different context, but I’ll come to that later on). In performing this analysis, I’ve used the middle-of-the-road growth-and-income funds and growth mutual funds. These funds include the large, well-known funds, and carry risks at about the same level as the Standard & Poor’s 500 Composite Stock Price Index. (Aggressive growth funds, small cap funds, and international funds, which carry generally different—and higher—risks are excluded.) This graph (Exhibit II) shows how the four quartiles of funds, ranked by performance relative to the Index in the first decade, regressed toward the market mean during the second decade.for

Most own at least two Vanguard funds, and many own five, six, seven or more. Through the miracle of technology, they now receive a single combined statement for all of them, in the mail or, for the many whom have elected to skip the paper, electronically. Two million of those shareholders own Vanguard funds in their 401(k) corporate retirement plans, along with hundreds of thousands who own our funds through our variable annuities, or our brokerage affiliate, or our defined benefit administration, or our asset management and trust division, so we actually must maintain six separate record-keeping systems. Nonetheless, today our shareholders can view a combined electronic statement that combines all of their accounts through our “Access Vanguard” website, which receives about 100,000 visits each day. This is a remarkable and valuable service and a big cost saver as well.Forward

I do not believe it is possible—ever—to improve on our basic strategy of providing investors with virtually 100% of the long-term returns available in the financial markets, simply by owning those very markets at minimal cost. By doing so, we have stripped the mystery from the investment process. You’ve heard me call our structure “the majesty of simplicity in an empire of parsimony.” And it works! If we remain faithful to that legacy, I assure you, this enterprise—of the shareholder, by the shareholder, and for the shareholder—shall not perish from the earth. “Press on, regardless,” and stay the course.

Consider his creations: The Colonies’ first fire company; our oldest property insurance company, still thriving today; the Franklin stove, whose stunning efficiencies slashed families’ heating costs; and the lightning rod; along with a library, a hospital, and a college (now the University of Pennsylvania). Now there is one truly eclectic entrepreneur! The Purpose of Entrepreneurship: Service to Others And that brings me to my second point: the true purpose of entrepreneurship is service to our community and our world. Franklin’s imagination, energy, and persistence were focused on public weal, and not personal profit. He refused to patent his “Pennsylvania fireplace”; he made the lightning rod freely available; and his insurance company was, of all things, “mutual.” (As it happens, the same form of organization we chose for Vanguard.) “Knowledge is not the personal property of the discoverer,” Franklin believed, “but the common property of all. As we enjoy great advantages from the inventions of others, we should be glad of an opportunity to serve others, freely and generously, by any invention of our own.” And so it should be for all of us. As you budding entrepreneurs go home this evening, dreaming your dreams of today, even as you realize that you’ll likely have new and even bolder dreams tomorrow, I urge you never to stop dreaming and creating.common

This new book, subtitled The Only Way to Guarantee Your Fair Share of Stock Market Returns, focuses on the simple, straightforward, and, I think, unarguable premise that all of this activity is extremely harmful to the wealth of investors . . . . in fact, to the tune of about $400 billion per year. Why? Because of these simple facts; (1) that owning American business for the long term is a winning game (businesses, after all, earn a return on their capital and distribute a major part of those earnings or dividends); (2) that beating the market (before the costs of financial interdiction) is a zero-sum game; and (3) that beating the market after costs is a loser’s game. I call these obvious principles “the relentless rules of humble arithmetic,” in the long-ago words of Supreme Court Justice Louis D. Brandeis. The Index Fund The way to guarantee your fair share of the returns generated by business, of course, is to hold the market portfolio and eliminate all intermediation costs. While I’m confident that this room holds many skeptics about indexing, I’m equally confident that there is also a significant group here that agrees with my reasoning.with

” December 1949, Break #1—Fortune Smiles Fifty-three years ago, I was seated in the reading room of Princeton’s then brand-new Firestone Library and turned to page 116 of the December 1949 issue of Fortune magazine. There I read an article on a business I’d never even heard of: Mutual funds. Describing the industry as “tiny but contentious,” the story inspired me to choose this field as the subject of my senior thesis. In my thesis, I baldly asserted that “the prime responsibility of mutual funds must always be to their shareholders,” and to demand that funds must serve—“serve both individual and institutional investors . . . serve them in the most efficient, honest, and economical way possible.” I urged funds to reduce sales charges and management fees, to exercise their responsibilities of corporate citizenship, to refrain from excessive claims of management ability, and, almost eerily, to “make no claim to superiority over the market averages.”

They are the words—right down to the italics—of my great-grandfather Philander B. Armstrong, who conceived the idea of mutual insurance in the property field, and formed the Phoenix Mutual Fire Insurance Company in 1875. A decade later, he spoke those words to his fellow leaders of the insurance industry in St. Louis, Missouri. The fact that my own career in the mutual fund industry, and my own convictions as well, so closely resemble his must stand as a monument to the fact that even the apple’s apple’s apple’s apple doesn’t fall very far from the tree. __________ *Today, the quotation would properly read, “ladies and gentlemen.Matter—Enormously

But it’s easy to say that we shall not soon again see the recurrence of such an outpouring of wealth creation. To understand why, we need only heed Lord Keynes’ words, written nearly 70 years ago: “It is dangerous . . . to apply to the future inductive arguments based on past experience, unless one can distinguish the broad reasons why past experience was what it was.” But his warning also suggests that if we can distinguish the reasons why the past was what it was, we can then apply that very line of reasoning to the development of reasonable expectations about what may lie ahead. Keynes helped us make this distinction by pointing out that the state of long-term expectation is a combination of enterprise (“forecasting the prospective yield of assets over their whole life”) and speculation (“forecasting the psychology of the market”). I’m well familiar with those words, for 52 years ago I incorporated them in my Princeton University thesis on mutual funds, then a tiny $2½ billion industry.

Typically, the allocation might range from something as crude as, say, 50% in stocks and 50% in bonds for older, moderately risk-averse investors who have accumulated substantial capital, have reached normal retirement age, and need to draw down income. Or up to 100% stocks for young, confident investors who are just beginning to accumulate their first investments in a 401-K retirement plan, and have scores of years before drawing down income. In an uncertain world—and it will be ever thus—getting allocation almost right may be better than getting it precisely wrong. The fact is that we know little about the future returns that stocks and bonds will provide. But we must rely primarily on stocks for capital appreciation and on bonds for income, and we have to realize that stocks involve substantial risks. No matter what you read about historical returns of common stocks, I assure you that the stock market is not an actuarial table. But the common stock portion of your allocation provides the only sensible approach to building your capital over the long-term. So the question becomes: Which equity mutual funds will build your capital with the greatest effectiveness.Allocation

Our assets, $1 billion at the outset in 1974, now total $530 billion, marking us as the second largest mutual fund firm in the world and the fastest-growing company in the industry, with the highest level of client loyalty; and the lowest costs of any provider—by far—of financial services on the face of the globe. Patterns of Industry Growth Since our inception, we have grown at a 27% annual compound growth rate—and a steady one at that. Charting our mutual fund assets on a semi-logarithmic chart results in something akin to a straight line. Our huge base in recent years has grown at essentially the same rate as our tiny base grew in the early years. Just a decade ago, when our assets totaled $40 billion, I drew a chart that projected what our 1999 assets might be, based on various future rates: 30% (“inconceivable,” I said); 20% (“unlikely”); and 10% (“easy”—our investment returns alone ought to do that job, with new investments from investors adding incremental assets). Well, with $530 billion as 1999 ends, our 27% historic growth rate hasn’t yet gone away (Chart 2). Nonetheless, I was ever fearful of the challenge of unbridled growth both on investment strategy and on organizational effectiveness back in 1989. So I entitled the chart, “The Tyranny of Compounding.”

I won admission to Princeton, and, to make it financially possible for me to go there, the University gave me both a full scholarship and a job. With a series of summer jobs (one as a reporter on the police beat for The Evening Bulletin), I was able to earn the remaining money I needed. I worked very hard, and the hours were long. But I loved hard work then—I still do—and was determined, in some way that I’m still not at all clear about, to get ahead. I was blessed by a loving and strong family—proud grandparents, loving parents, a marvelous brotherhood of three that fought among each other, but when others wanted to take us on, we were united. And I grew up with the priceless advantage of having to work for what I got. My father soon moved to New York, and my mother, terminally ill, remained in Philadelphia. I wanted to return here to be with her after my graduation in 1951, and fate intervened to make that goal a reality. At Princeton, this callow, idealistic young kid with a crew cut had determined to write his Economics Department senior thesis on a subject no one had ever written on before. Not Lord Keynes, not Adam Smith, not Jean Baptiste Say, but a subject fresh and new.I

Started opportunistically, they fail frequently, their goals largely unfulfilled. During the 1960s, 14% of all funds failed to survive the decade. During the 1990’s, 55% of funds—more than one half!—failed to survive. And I’d bet that more than half of today’s 4800 equity funds won’t be around a decade hence. This diminution of our traditional long-term focus has ill-served fund investors. (Chart 1) 1000 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 New Equity Funds Disappearing Funds Mutual Funds: Investments vs. Products Equity Fund Failure Rate 1960s - 14 % 1970s - 62 % 1980s - 21 % 1990s - 55 % Chart 1. 108% 74% 111% 75% 48% 15% 0% 20% 40% 60% 80% 100% 120% 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98'00 Average Annual Portfolio Turnover of Equity Mutual Funds Mutual Funds: Investing vs. Speculating Chart 2.

earnings had more than doubled to 31 percent. That can’t surprise you. Nearly all large U.S. firms can be characterized as “global” in their reach. Think Coca-Cola, IBM, Microsoft, GE, General Motors, and Citigroup, and you’ll get the idea. And, in this “one world” of interconnection and competition, global stock markets continue to produce similar long-term returns. For example (this may surprise you), since 1980 the annual return on the S&P 500 has averaged 13.0 percent compared with the return of 11.6 percent for the non-U.S. EAFE Index (the Morgan Stanley Capital International Europe, Australia, and Far East Index). A percentage point of that return, in fairness, has resulted from the moderate weakness of the dollar over that long span; the EAFE annual return, measured in local currencies, was 10.6 percent. That is not to deny that there can be extended waves of superiority in one segment or the other. During the 1980s, international (i.e., non-U.S.) stocks substantially outpaced U.S. stocks (22 percent per year vs. 17 percent) and then fell far behind in the 1990s (U.S.per

An article in The Economist noted their finding that economic puzzles regarding international trade, savings and investment, investors’ preferences for domestic portfolios, and the lack of relationship between exchange rates and economic activity all prove to have a common denominator: The cost of trade. Trade costs money, they argue. And when trading costs reach 25% of the cost of goods, expected outcomes don’t materialize. And so it is in the financial markets as well. Reality Bites Theory So, while Bachelier was right that the mathematical expectation of the speculator—and, for that matter, the long-term investor—in outpacing the returns earned in any given segment of the financial markets is zero, that expectation implicitly assumes that costs too are zero. But after the costs of speculation (or investing) are taken into account—after all of the fees, the transaction costs, and the hidden costs of financial intermediation—the mathematical expectation is for a loss precisely equal to those costs.ominous

Decision — Built GameStop position; published board letters. Context: Forbes transcriptions of the letters survive. Outcome (partial): Exit timing Q4-19/Q1-20 lacks a filing-by-filing map (gap).

The Sharpe ratio takes the return on the Fund, subtracts a so-called risk-free return (basically the return on government bonds) to get the excess return over the risk-free rate, and divides the resulting number by the variation in that excess return (measured by its standard deviation — I warned you it was gobbledegook). The result tells you what unit of return you get for a unit of risk and our Fund has a Sharpe ratio of 0.79 since inception against 0.43 for the MSCI World Index — it is producing about twice the amount of return that the Index produces for each unit of risk. The Sortino ratio is an adaption of the Sharpe ratio, and in my view an improvement. Whereas the Sharpe ratio estimates risk by the variability of returns, the Sortino ratio takes into account only downside variability as it is not clear why we should be concerned about upside volatility (i.e. when our Fund goes up a lot) which mostly seems to be a cause for celebration. The result for our Fund since inception is a Sortino ratio of 0.71 but the MSCI World Index Sortino ratio is lower than its Sharpe ratio at 0.39.producing

Deveshwar then went on what Open calls a diversification spree with a 'let's put India first' clarion call, transforming the Kolkata-based cigarette maker into a conglomerate spanning FMCG, paper and packaging, hotels, agriculture and information technology. When he took over in 1996, nearly 75% of ITC's revenues came from tobacco; by the time of writing tobacco was down to slightly over 40% of revenues.

In the soaring stock prices of 1999 and the first half of 2000, for example, when fund cash flows from individual investors were $400 billion, the mix was 90% stock funds and 20% money market funds, with 10% actually withdrawn from bond funds. Then, when the stock market reversed course over the next year and one-half, industry cash flows remained strong at $290 billion, but the mix was 30% bond funds, 30% money market funds, and only 40% equity funds. Clearly, mutual funds have successfully made the transition from the old equity-oriented industry that we knew from 1924 (when the first U.S. fund was formed) right up to 1975, when the money market fund was introduced. Shortly thereafter, in that seemingly ancient era of the early 1980s when yields were at double digit levels and investors wanted, of all things, income, from their investments, money market funds dominated the industry, with bond funds not far behind. (In a 1992 speech, I described bond funds as “the third mutual fund industry.”)

Let me count the ways, comparing the industry I entered in 1951—56 years ago, almost back to your founding in 1947— with the industry I see today.3 1. Enormous Growth. Then, mutual fund assets totaled $2 billion; today, assets total more than $11 trillion, an astonishing 17 percent rate of annual growth. 2. Investment Focus. Then, almost 80 percent of stock funds (60 of 75) were broadly diversified among investment-grade stocks, pretty much tracking the movements of the stock market itself and lagging its returns only by the amount of their then-modest 2 The Little Book of Common Sense Investing—The Only Way to Guarantee Your Fair Share of Stock Market Returns (John Wiley & Sons, 2006) 3 In the interest of time I’m confining these remarks largely to equity funds, which now represent about 70 percent of mutual fund assets.

Getting to the here of 2000 from the there of 1985 was not easy. I think (and Bob DiStefano agrees with me) that the major turning point came in 1992, with the delivery of my “Sacred Cow” speech at our executive meeting in mid-year. In it, I announced that my somewhat heavy-handed, Luddite-type approach to our business could, in a rapidly changing New World, retard our progress. I presented the staff with a list of seven Vanguard business principles—I called them “Sacred Cows”—that the officers felt, probably reading me correctly, we would never violate. I told them that those principles that involved our basic investment philosophy and our fundamental human values indeed were sacred, but that other policies would have to be killed if we were to remain competitive. By the time my speech was over, four of the sacred cows were dead, including number two: “We shall not be a technology leader.” To visualize its demise, I created an imaginary article from a bogus June 1992 issue of the aforementioned Forbes magazine, in which I was quoted as reversing the cautious and provincial position I had expressed seven years earlier. The new quote read: “We are going to be the technology leader. We cannot afford not to be.” We began by bringing in Arthur D. Little to develop a major analysis of our technology operations, the beginning of a year-by-year series of quantum leaps that took our technology from 1990s followership to year 2000 leadership.

Both Bansals personally interviewed nearly every early hire, holding the talent bar high because, in Binny's view, no other lever scales a young company as cleanly. The cultural premium on hiring also fed directly into the founders' later push to make Flipkart 'founder-proof' — meaning, capable of running without either of them at the helm.

sense. And never give up. Never, never, never, never, never! All it takes in this world is energy and persistence, although, confession being good for the soul, having a few lucky breaks is likely to do you no irreparable harm. Dreams Do Come True We are all blessed to live in a land where dreams not only can come true, but do come true. Learn from other entrepreneurs who have been around the blocks of life a few times. Take what you can, too, from my humble thoughts this evening. But above all, be true to yourself. It will not be easy—nothing worthwhile ever is—but when you reach your goal, please remember to share it with your society, for that is what entrepreneurship is really all about. And as you struggle, never forget that, however flawed this great nation has been in living up to the promise of her Founders, we are all “created equal,” endowed by our Creator with unalienable rights “to Life, Liberty, and the Pursuit of Happiness.” The rest is up to you. So, all of you entrepreneurs here tonight, youngsters and oldsters alike, “Press On, Regardless.” And may God bless you always.

“indexing” as such, and almost everything to do with simply owning U.S. business (or global business) in its entirety, through a capitalization-weighted portfolio of our total stock market, and then holding that portfolio for Warren Buffett’s favorite holding period: “forever”. Simply put, if an investor buys the market portfolio, pays no sales loads, no management fees, tiny operating costs, and no portfolio transaction costs, and holds it forever, that investor will capture virtually 100 percent of the stock market’s annual return. On the other hand, for the average investor buying actively-managed funds (or for that matter, engaging in any strategy that involves heavy trading), usually carrying commissions, substantial management fees, heavy operating and marketing costs, huge costs of portfolio turnover (the average equity fund now turns its portfolio over at an astonishing rate of 100 percent per year!), that investor’s return will fall far short of the market’s return. How far short? Well, those all-in mutual fund costs that I just enumerated presently come to something like 2 ½ percent of assets per year. Since the average mutual fund manager is, well, average—you heard it here!—the return of the average fund has fallen short of the return of the Vanguard 500 Index fund by about 2 ½ percentage points over the past quarter century. And simply because of those costs, the average fund is destined to fall short by a similar amount in the years to come.

The Boom and the Bust Well, despite the fact that this industry has failed—and failed abysmally, in my view—to measure up to the high ideals I expressed all those years ago, grow it did. And as the great bull market in both stocks and bonds that began in the early 1980s produced the most generous investment returns in all our nation's history, it grew massively. In the greatest bull market in all history, the market capitalization of U.S. stocks grew from less than $1 trillion to $17 trillion. "We never had it so good." But the good times didn't— couldn't—continue to roll by and these recent years have not been very happy ones for idealists. The disgusting recent scandals in some of the fund industry's largest firms are only the small tip of a very large iceberg; soaring fund expenses and moving our focus from prudent management to opportunistic marketing have imposed far larger costs on our investors. Chart – Total Market Capitalization, 1950-2003 Since the great stock market bubble of the late 1990s burst, we have endured the painful experience of the greatest bear market in stocks since 1929–33, with more than $8 trillion erased in the plunge. But most of the air that inflated the bubble was hot air— enormous investor expectations that could never be fulfilled, fed by the aggressive growth projections of corporate managers that were both self-serving and grossly unrealistic. Small wonder that the bubble quickly deflated.

cost provider of financial services in the world, able to provide commensurately high returns to our investors. The strategy may seem obvious to you today; let me say that it seemed equally obvious to me in 1974. So, let’s mark foresight as a second attribute of leadership. A third attribute is, I think, a sense of purpose. In 1974, we had a conviction about where we wanted to go and a commitment to do so ethically, with a strong moral compass as our guide. Our purpose was solely to serve our shareholders, those who would entrust the stewardship of their financial futures to us. So, we created a corporate structure in which our clients literally became our owners—a structure that remains unique in the mutual fund industry to this day. The current aphorism, “treat your customers as your owners,” took on real meaning for us, as our corporation turned its ownership over to the shareholders of our mutual funds—not, as in industry practice, to a privately or publicly-held profit-seeking corporation. While I’ve been called a fool, a Communist, and even a Marxist (and in public, at that) for creating our corporate structure, it seems to me to represent the very essence of capitalism: the control of the corporation by its shareholders.

opened FORTUNE magazine to page 116 and read an article (“Big Money in Boston,” of all things) on a financial instrument of which I had never before heard: Mutual funds. When the article described the industry as “tiny but contentious,” I knew that I had found my topic. After a year of intense study of the mutual fund industry, I wrote my thesis and sent it to several industry leaders. One was another diamond, right here in Philadelphia Walter L. Morgan, mutual fund pioneer, the founder of Wellington Fund, and member of Princeton’s Class of 1920, read my thesis. He liked it, and was later to write: “A pretty good piece of work for a fellow in college without any practical experience in business life. Largely as a result of this thesis, we have added Mr. Bogle to our Wellington organization.” I started right after my 1951 graduation, never looked back, and have been here ever since. Yes, my own acres of diamonds were in Philadelphia. And here began a friendship, one that was to endure for almost 50 years, with a remarkable human being. I have no way of knowing if it is true, as some of his close associates told me, that he thought of me as the son he never had.

Putting Numbers on Keynes’s Distinction While Keynes made no attempt to quantify the relationship between enterprise and speculation in shaping stock market returns, decades later it occurred to me to do exactly that. By the late 1980s, based my own first-hand experience and my research on the financial markets, I realized that equity returns were a combination of these two essential sources: enterprise and speculation. I defined enterprise as investment return— the initial dividend yield on stocks plus the subsequent annual rate of earnings growth. I defined speculative return as the change in the price investors are willing to pay for each dollar of earnings (essentially, the return that is generated by changes in the valuation that investors place on future corporate earnings).

The fact is that costs still matter. They matter in insurance and in mutual funds, and in all financial service industries. And they matter most where they are at once very large, compounded over time, and easily measurable relative to the value of the services provided. The confluence of those three factors is vividly etched in the investment record of the mutual fund industry. During the past 15 years, for example, the return of the average equity mutual fund lagged the return of the total stock market by 2.75% per year (before taxes). Industry costs— fund operating expenses, marketing expenses, and advisory fees; sales charges and portfolio turnover costs—amounted to about 2½% per year. Assuming a continuation of that cost level and a normalized market return of, say, 10% per year, a $10,000 initial investment, simply invested in the stock market and compounded over a time period of 40 years—many of today’s investors will own fund shares over a far longer period—would grow to $452,600. Invested in an equity fund, however, it would grow to but $180,400. Starkly put, the fund investors would accumulate 38% of the capital provided by the equity market, and the suppliers of fund services would confiscate the remaining 62%. In other words, the investor puts up 100% of the initial capital, assumes 100% of the risk, and receives 38% of the return. The croupiers, having put up none of the capital and having assumed none of the risk, consume 62% of the return.

outstanding staff. But I did my best, and left the National Constitution Center a better place—indeed a real, living, growing institution that is bringing our Constitution back into its deserved position in the mainstream of American life—than I found it in that original vision that I signed on for in 1988—then a wonderful vision, but only a vision, now become a reality. Blair Academy The education of our young citizens is another area of considerable interest to me. While I’m deeply troubled by the profound shortcomings of our nation’s schools—and fully understand that these seemingly intractable problems arise in important measure from disturbing societal issues, including poverty, racial discrimination, drugs, and the gradual erosion of the traditional, well, “nuclear family” in which children are raised by both parents—I long ago decided to focus my own limited talent on a narrow subset of the educational universe. Let me tell you a bit about that decision. From kindergarten through tenth grade I attended public schools of moderate ambitions—making small demands on students, and with limited curricula, albeit with some superb teachers. But my parents, ambitious for their three boys, realized that we were all capable of meeting more demanding standards.

If the words about efficiency, honesty, and economical operation strike you as a design for a firm called Vanguard, and if the idea that funds can’t beat the market seems to lay the groundwork for the index fund, so be it. But those things are probably what any young college student, idealistically seeking to build a new and better world, would have written. Whatever the case, the thesis led me directly into a career in this industry, for it was read by Walter L. Morgan, long-time member of the Union League, fellow Princetonian, legendary fund pioneer, and founder in 1928 of Wellington Fund. When I graduated in 1951, Mr. Morgan hired me. With few hardy souls having come into the beleaguered investment field during the 1930s and 1940s, my ascent was rapid. This fine gentleman groomed me, challenged me, trusted me, and liked me—we were friends for nearly half a century until his death at age 100 four years ago—and by 1965, at age 35, I was running his company. Mr. Morgan told me “to do whatever it takes” to prepare Wellington for the future. Headstrong, self-confident, and immature, I took a radical step, merging Wellington Management Company with a Boston investment firm. But I relinquished too much of Wellington’s voting control for my own good. While at first the merger was an extraordinary success, the end of the speculative boom of the “go-go” 1960s and the onset of the great 1973-74 bear market brought tough times.

almost twice the return that the Index produces for each unit of downside volatility. As you hopefully know by now, we have a simple four step investment strategy: • Buy good companies • ESG screen • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first of those — whether we own good companies — by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market, in this case the FTSE 100 Index and the S&P 500 Index (‘S&P 500’). We not only show you how the portfolio compares with the major indices but also how it has evolved over time. Year ended Fundsmith Sustainable Equity Fund S&P 500 FTSE 100 2017 2018 2019 2019 2019 ROCE 28% 30% 29% 17% 17% Gross margin 63% 65% 65% 45% 39% Operating margin 26% 28% 26% 15% 17% Cash conversion 102% 95% 99% 84% 86% Leverage 37% 47% 22% 53% 41% Interest cover 17x 17x 17x 7x 10x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Profit Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Sustainable Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are both median.

The perfect plan would be to identify one or more mutual funds that may provide a return significantly greater than that of the stock market. And the lesson of history shows us that some mutual funds have in fact outpaced the market. But that lesson also shows us that the odds against doing so are long. In fact, even among those 145 mutual funds that have in fact survived the past three decades, only 15 have outpaced the stock market as a whole. That is, the fund investor had only about one chance out of ten to surpass the market’s return. By how much? An interesting question. Only eight funds outpaced the market by more than one percentage point per year. Thus, when we eliminate the likely statistical noise involved in a margin of plus or minus one percentage point to the market, the odds of success now drop to just one chance out of 18. And the chances of picking a loser are far higher. A total of 108 funds fell one percentage point or more behind the market, 13 losers for each winner. And fully 37 funds—one of every four—fell short of the market by three percentage points per year, surely a deep disappointment to their owners. Clearly, the odds against implementing a perfect plan by selecting winning funds are long, and the penalties for failure disproportionately large. Why was it so difficult for these mutual funds to merely match the return of the stock market?

markets come and bull markets go, inevitably followed by bear markets, which too come and go. But these pillars of wisdom are timeless, and should serve us well in all seasons. I’d like to review them with you today. Pillar 1. Investing Is Not Nearly as Difficult as It Looks. The intelligent investor in mutual funds, using common sense and without extraordinary financial acumen, can perform with the pros. In a world where financial markets are highly efficient, there is absolutely no reason that careful and disciplined novices—those who know the rudiments but lack the experience—cannot hold their own or even surpass the long-term returns earned by professional investors as a group. Successful investing involves doing just a few things right and avoiding serious mistakes. “Doing a few things right,” as I stressed in my book, included focusing on broad-based mainstream equity funds with wide diversification; evaluating funds relative to peers with similar objectives; ignoring short-term performance in favor of performance over at least a decade; carefully considering the drag of high expense ratios and sales charges; paying careful attention to portfolio quality, in stock funds, bond funds, and money market funds alike; and focusing on an asset allocation that is consistent with your own risk tolerance.

Zhang retained the chairman title and majority voting control of ByteDance after the CEO handover, and TikTok's continued global growth made him the richest person in China by 2024, per Wikipedia's citation of Bloomberg data.

enthusiasm again, this time in a different way (!), I plunged into the exciting challenge of building a new enterprise, an enterprise that would stand for something powerful: Stewardship—giving average investors a fair shake at building their own financial independence. And what else could explain that, at the very moment I was searching for an appropriate name for the firm, I came across a book recounting the history of the Napoleonic wars and the Duke of Wellington? I opened it to the very page that described the sweeping victory over the French at the Nile, won by Admiral Nelson aboard (you guessed it!) HMS Vanguard, the name I immediately chose for my new enterprise. And as we began, providence moved yet again: Some words that I’d written in my Princeton thesis nearly a quarter-century earlier happened to come back to me: “Mutual funds can make no claim to superiority over the market indexes,” words that led us to pioneer the index mutual fund—a fund that wins the investment race simply by owning the stock market and holding it forever. That first index fund, the backbone of our firm’s success, is now the largest mutual fund in the world. A Second Chance at Life If that series of unforeseen incidents in my life is not proof enough that commitment is rewarded by providence, I still have one more. Five years ago, at death’s door after fighting against a rare genetic heart disease for 35 years, I became the beneficiary of a heart transplant.

Exhibit I: Source of Variations in Return* Factor BHB Study Vanguard Study Allocation Policy 92.5% 88.7% Allocation Changes and Security Selection 7.5 11.3 Total 100.0% 100.0% _________________ *Average of BHB’s 1986 and 1991 studies; Vanguard study based on ten years ended December 31, 1996. Turning from variations in return to total return, both the pension plans and the mutual funds displayed returns before expenses that fell slightly short of the returns of the market index benchmarks. For the balanced funds, we used the Standard & Poor’s 500 Index for stocks, the Lehman Intermediate-Term Corporate Bond Index for bonds, and U.S. Treasury Bills for cash. (In neither the BHB study nor in our study did the results vary significantly if the all-market Wilshire 5000 Equity Index were used instead of the S&P 500.) What we are witnessing, as has been reaffirmed over what seems like time immemorial, is the failure of active mangers, on average, to outperform appropriate market indexes. Exhibit II: Returns Before Costs BHB Study Vanguard Study Index Composite Return 11.8% 12.5% Fund Composite Return (before costs) 11.2 12.3 Difference -0.6% -0.2% It seems likely that portfolio transaction costs were a material factor in both the pension plan and the mutual fund shortfalls to the unmanaged index portfolio. Undistinguished individual stock selection (or, if you will, highly efficient markets) simply meant that the active manager failed to add value.

Investment Return and Speculative Return This dual nature of investment returns is clearly reflected in the stock market history, and remains basic in appraising the state of the stock market today. I continue to use the term speculative return to refer to the portion of the stock market’s total return that is derived from “changes in the public valuation”—that is, the changes in the price that investors are willing to pay for each dollar of earnings per share. But rather than using Keynes’ term enterprise to describe the yield of an investment over the years, I use the term investment return—the sum of the initial dividend yield plus the annual growth rate of earnings; that is, the return that corporations actually deliver to investors. Added together, investment return plus speculative return represent the total stock market return we experience. History illuminates this division of stock market returns with great clarity. The reason that stocks returned nearly 20% per year during the great bull market are clear: The dividend yield on the S&P 500 Index averaged almost 5%, the subsequent annual earnings growth was just short of 7%; the combined investment return, then, was almost 12%. But as the fear of investors at the outset changed to hope and finally to greed, the price-to-earnings ratio quadrupled—from nine to 36—adding more than eight percentage points of speculative return. The math is not very complicated: An average annual return on stocks of almost 20%.

This is not to say that the history of capitalism is without blemishes, and profoundly serious ones at that. Among its moral failings are the early abuse of child labor, and the continuing misuse of natural resources, the lack of adequate concern about our society and the environment, and its growing role on political campaign contributions in shaping vital national issues. But in the recent era, one of the main failings of capitalism is as a system of corporate ownership. It has departed, not just in degree but in kind, from its proud traditional roots, a system that served us, despite its imperfections, with remarkable effectiveness for the better part of the past two centuries—a free enterprise system based on open markets and private ownership, and on trusting and being trusted. The system worked. Or at least it did work. And then, as I write in Battle, “Something went profoundly wrong, fundamentally and pervasively, in corporate America. At the root of the problem, in the broadest sense, was the societal change aptly described by these words from the teacher Joseph Campbell: ‘In medieval times, as you approached the city, your eye was taken by the Cathedral. Today, it’s the towers of commerce. It’s business, business, business.’ We had become what Campbell called a ‘bottom-line society.

return of 16%. The price-earnings ratio rose from 11.1 times, to 11.8 times, for a 6% speculative return. Result: Market return for the year, 22%. Long Term Investing is about Economics Now let’s examine these two sources of return over the long run. Over the past 130 years, the market return of U.S. stocks has averaged 9.0% per year. The annual investment return from earnings and dividends has averaged 8.8%; the speculative return just 0.2%. Were this a football score, it would read: Economics 88, Emotions 2. Long-term investing is all about economics. That virtual one-for-one parity between economic return and market return, however, is something we rarely see. Pendulum-like, the cumulative investment return swings way above the market return, and then way below. When emotions turn negative, and P/E ratios fall, the speculative return sharply diminishes the investment return. From 1961 through 1981, for example, a fall in the P/E from 23 times to 8 times—from optimism at the beginning of the period to pessimism at the end—resulted in a negative speculative return of minus 4.6% annually, slashing the 12.1% annual investment return by almost 40% to a market return of just 7.5% $0 $1 $10 $100 $1,000 $10,000 $100,000 1872 1882 1892 1902 1912 1922 1932 1942 1952 1962 1972 1982 1992 Investment Return 8.8 % (earnings growth plus yield) Market Return 9.0 % (includes speculative return*) Annual Growth Rate Stock Market Total Return vs.

again in January. Taking money out of the market at lows and putting back in at highs is not the best way to make money. What was in truth not much more than a short-term blip on the stock chart-and a blip that was certainly long overdue-seemed to change investor confidence in a meaningful way. In addition, the decline increased investor activity in stock funds to a level even higher than the microscopic three-year average holding period prevailing earlier-a shocking short-term orientation for investors in what I believe is the finest medium for long-term investing ever devised. So, I remind fund investors, and the fund industry, both so focused on short-term returns, of the need for long-term thinking. The third principle: Invest for the Long Term. It applies to mutual funds and investors alike, but in both cases it is honored more in the breach than in the observance. The wild and wooly decline and the subsequent powerful recovery, I think, have got fund investors focusing on the short-term when they should be focusing on the long-term. So I'd now like to take a look at what might be realistic expectations for long-term returns on stocks. To begin with, stocks-by all traditional measures-are very highly valued. Consider these valuations, measured today vs. the start of the great long-term bull market: Prices have risen from 7.9 times earnings to 28 times earnings; dividend yields have fallen from 6% to 1.3%.

operating costs. Today, such “large cap blend funds”4 account for only 11 percent of all stock funds. These 500 “market beta” funds are now overwhelmed by 3,100 U.S. equity funds diversified in other styles; 400 funds narrowly-diversified in various market sectors; and 700 funds investing in international equities—some broadly diversified, some investing in specific countries. The challenge in picking funds, dare I say, has become roughly like the challenge in picking individual stocks. I don’t consider that progress. 3. Investor Behavior. But fund investors no longer just pick funds and hold them. They trade them. In 1951, the average fund investor held his or her shares for about 16 years; today that holding period averages about four years. To make matters worse, fund investors don’t trade very well. Because they usually chase good performance, and then leap out after bad performance, the asset-weighted returns—those actually earned by fund investors—have trailed the time-weighted returns reported by the funds themselves by an astonishing amount—more than 6 percentage points per year over the past decade. (Cumulative 10-year return reported by the funds: 133 percent; return earned by their investors, 27 percent.) Astonishing! And depressing. 4. Investment Process. In 1951, funds were typically managed by investment committees. Today I can’t identify a single fund run by a committee.

is the best-recognized source), and they show that the average mutual fund has provided an Alpha-a risk-adjusted return relative to the market~f -1.9% per year during the past decade. This number roughly equals the industry's estimated annual costs of 2.1 %. It is no accident that these figures are normally quite similar. But alas (from the industry's standpoint), the news is about to get worse. To tell you why, let me move further along the parallax, and view the tax aspect of cost-a vital element in my own three-dimensional view of an industry that is too often looked at in only the two dimensions of risk and return. Taxes: The Industry's Black Sheep The tax issue is the black sheep of the mutual fund industry-like the cousin who can't get her life together or the uncle who drinks too much-best kept out of sight and out of mind. If the industry feels that way, however, the shareholder cannot afford to. For it is the shareholder who pays the taxes on a mutual fund's income dividends and capital gains distributions generated by the fund's constant staccato of portfolio sales, and-at least in these halcyon bull market days-the realization of enormous taxable capital gains. The dichotomy is that a portfolio manager's performance is measured and applauded on the basis of pre-tax return-never mind that the Internal Revenue Service confiscates a healthy share of it.

sense—of devices that would improve the community’s quality of life. And third, his view that virtue is not only achievable by us mortals, but is the principal requirement of a life well lived. In each case, I shall deal both with Franklin’s accomplishments of yore and with the humble parallels reflected in the creation of Vanguard and the innovations we have brought to the investment community, which drive our growth to this day. I. Mutuality In the eighteenth century, fire was a major and ever-present threat to cities. In 1735, when barely 30 years of age, Franklin responded to that threat by founding the Union Fire Company, literally a bucket brigade that protected the homes of its subscribers. In a short time, numerous other fire companies sprang up. Fire protection became sort of “every company for itself”—but only until it occurred to Franklin that if Philadelphia’s fire companies joined in common cause it would be possible to insure the homes under their aegis against financial loss when a fire took place. So Franklin joined with his colleagues in founding The Philadelphia Contributionship on April 13, 1752, following public notice in The Pennsylvania Gazette.

The Birth of a Bubble How did such a bubble ever come to pass? I suppose we’ll never know precisely, but it doesn’t require much analysis to assign the responsibility to a remarkable confluence of events like these: A once-in-a-generation economic boom, with record growth in corporate earnings; the optimism of the new millennium; a time of unity (mostly) in the U.S. and of peace (mostly) around the globe; the ebullience engendered by a quarter-century-long bull market, without a single protracted decline; the intoxicating hype of the financial press and the television networks; and the siren song of a New Era—“the Information Age.” Wired magazine was among the first to trumpet the New Era’s grand promise. In an article entitled, “The Long Boom,” published in mid-1997, the headline read: “We’re Facing Twenty-Five Years of Prosperity, Freedom, and a Better Environment for the Whole World. You Got a Problem with That?” No, “I got no problem with that.” Who among us could possibly have a problem with “watching the beginnings of a global boom on a scale never experienced before. . . entering a period of sustained growth that could eventually double the world’s economy every dozen years and bringing increasing prosperity for--quite literally--billions of people on the planet . . . that will do much to solve seemingly intractable problems like poverty and ease tensions throughout the world, all without blowing the lid off the environment.

In short, speculation (betting on higher valuations) is the drivers seat. Investment (betting on the fundamentals of dividend yields and earnings growth) is in the back seat—perhaps even in the rumbleseat. But while speculation drives stock returns in the short run, it is the crystal clear lesson of history—at least of the past 200 years—that in the long-run fundamentals drive returns. And so the tension must be resolved. Two extreme possibilities: One: a market drop of, say, 35%. This would lower price-earnings ratios to a more normal level of 13 times. And, at 5200 on the Dow, we would still repose--I might add, “fat, dumb, and happy”-- where we sat in January 1996, but a year and one half ago. This would hardly be a doomsday scenario. Two: a New Era, in which stock returns average 15% (14% earnings growth plus a 1% dividend yield), rather than the long-term historic norm of about 10.5% (6.5% earnings growth plus a 4% dividend yield). In short, a new era of boom times and high valuations that would justify today’s price levels. Indeed, Barton Biggs, the eminent if volatile guru at Morgan Stanley, bearish as he has been for so long (“Famine will follow feast, as it always has.”) entertained this idea a few months ago in a paper entitled “A New Higher Mean to Revert to?” (He did at least include the question mark.) He tranced on a new real mean of 10% (after inflation), but finally fell back on a 7%-8% range, not nearly enough, I think, to justify today’s price levels.

say that there has been an extraordinary increase in the portion of corporate earnings that corporate managers have arrogated to themselves. Consider the facts: From 1988 to 2001, while the annual compensation of the average worker rose 60%—from $16,700 to $26,800—the compensation of the average CEO rose 443%, from $2,025,000 to $11,000,000. It would be one thing if this quantum increase in executive compensation was justified by corporate achievement. But that’s simply not the case. From 1988 to 2001, executives promised investors growth in operating earnings that averaged 12%, but delivered only 3.5%—less than the 5.5% annual growth in our nation’s GDP for that period. And even that humble record greatly overrates the accomplishment of our corporate leaders. Reported earnings—earnings reduced by write-downs of bad corporate investments—averaged $24.70 for the companies in the Standard & Poor’s 500 Stock Index in 2001, barely above reported earnings of $23.75 in 1988. It’s difficult to see any evidence of extraordinary accomplishment in these figures. Much of the compensation increase has been fueled by executive stock options— described by compensation consultants as “free” simply because (unbelievably!) they do not appear as a cost in the company’s profit and loss statement. Options are almost universally described as “linking the interests of management to the interests of shareholders.” But the fact is that there is no such linkage.

mutual fund firms to better serve our clients? The answer is multi-faceted, for as we adjust to the information age technology is playing many roles in the financial business. Here are the seven questions that I’ll consider with you: (1) Does technology enhance the returns of mutual fund investors? (2) Does technology help us to create better investment products? (3) Does technology afford our investors better information? (4) Does technology help us to provide better communications? (5) Does technology help us to provide better services? (6) Does technology offer our clients better financial advice? (7) Does technology give us a better cost structure? As I focus on these issues, I am reminded of the timeless message of Vanguard’s long- time Chief Technology Officer, Robert A. DiStefano, whose inspired leadership, mastery of the IT field, and compassionate human values brought us into the Information Age with flying colors. His death last summer, at far too early an age, only magnifies that message: “How we do technology is far less challenging than deciding what we do. We must be clear on our objectives and our strategies, and allocate our resources accordingly. We must set intelligent priorities and have clear business objectives for each project we undertake, and serving our clients must be at the heart of all we do.” The Economist of London said pretty much the same thing: “Durable client relationships are only partly about clever technology, however imaginatively used.

you that my youthful idealism remains intact. Indeed, it is shamelessly reflected not only in Vanguard, but in my new book, an expression of my concern about our American society today, my conviction that our system of capital formation is essential to our economic growth and world leadership, and my acknowledgement that much has gone wrong in that system. There is much that needs to be fixed, for “the business and ethical standards of corporate America, of investment America, and of mutual fund America (the three principal elements of the book) have been gravely compromised.” In each of these three arenas, I discuss not only what went wrong, but why it went wrong, and how to go about fixing it. Right at the outset I warn the reader that mine is a tough message, bluntly delivered, opening with this epigram from St. Paul: “If the sound of the trumpet shall be uncertain, who shall prepare himself to the battle?” In this case, the battle is for the soul of our capitalistic system. Today’s Capitalism So my trumpet, as you’ll now hear is a certain one. Today’s capitalism has departed, not just in degree but in kind, from its proud traditional roots, a system that served us admittedly imperfectly, but with remarkable effectiveness for the better part of the past two centuries—a free enterprise system based on open markets and private ownership, and on trusting and being trusted. The system worked. Or at least it did work.

But, with concentration of ownership power so widely diffused among mutual fund owners, legislative change will be required to force the development of a new mutual fund structure which will assure that the Journal’s standard is met: “the managers serve their shareholders and not themselves.”

Open credits Deveshwar with making ITC a global exemplar in sustainability — what current chairman Sanjiv Puri calls 'the only company in the world to become carbon positive, water positive and solid waste positive for over a decade'.

America is business.” When he expressed that thought in 1928, it was during an environment very much like that we’ve enjoyed in recent years, with the economy vibrant, the stock market booming, and confidence—even greed—in the driver’s seat. But the unreconstructed idealist who stands before you today would transpose that sentiment: “The chief business of business is America.” For if business—our remarkable system of entrepreneurship, innovation, capital formation, and financial markets—can properly claim considerable credit for the creation of America’s extraordinary abundance, surely it is business that must stand up and be counted in the resolution of the challenges our society faces today. For all of our nation’s success, we face a litany of monumental problems that, left unattended, will sully our role as the hope of the world. Consider the huge gap between the rich—and compared to the median per capita income of $1,400 per year in the rest of the world, that’s us and just about every one we know—and the poor, 34 million U.S. citizens living below the poverty line. Consider crime. Yes, we read it’s way down, but even with nearly two million citizens already in jail, we are building 137 new prison cells every day. Our imprisonment ratio—one in every 100 adults—ties us with Russia as the world’s highest. Hardly unrelated to poverty and crime is the rampant use of drugs in our society, a business approaching $100 billion in annual volume.

Make no mistake: Business is an honorable career. Adam Smith told us why: “The pleasures of wealth and greatness strike the imagination as something grand and beautiful and noble, well worth the toil and anxiety . . . [they] keep in continual motion the industry of mankind, to build houses; to found cities and commonwealths, to invent and improve all the sciences and arts, which enoble and embellish human life; which have entirely changed the whole face of the globe, and [have paved] the great high road of communication to the different nations of the earth.” He wrote those words 230 years ago. Could it be better said today? Yet as I survey America at the millennium, I see our nation’s business values eroding. Yes, I see marvelous entrepreneurship, brilliant technology, and creativity beyond imagination. But I see far too much greed, materialism, and waste to please my critical eye. I also see an economy too focused on the “haves” and not focused enough on the “have-nots,” underinvesting in education, especially among those who need it most, not merely to prosper, but to survive. I see shocking misuse of the world’s natural resources, as if they were ours to waste, rather than ours to preserve as a sacred trust for future generations, and I see a political system corrupted by a staggering infusion of money that is, I assure you, rarely given by disinterested corporations that expect no return on their investment. Markets and Economics But I also see hope.

Ellis articles, to persuade a dubious Vanguard board of directors to approve the creation of the first index mutual fund. The idea of an index fund was hardly anathema to me. Way back in 1951, the anecdotal evidence that I had assembled in my Princeton University senior thesis on the mutual fund industry shaped my conclusion that funds “can make no claim to superiority to the market averages.” When the newly-formed Vanguard began operations in May 1975, I had realized my dream of establishing the first truly mutual mutual fund complex. While the idea of an index fund would have hardly appealed to a high-cost fund manager whose very business depended on the conviction that, whatever his past record, he could outpace the market in the future, indexing would be a natural for Vanguard. Uniquely, we operated on an at-cost basis and sought to become the world’s lowest cost provider of financial services. What is more, at the outset Vanguard provided only administrative services to our then-$1.4 billion fund group, which continued to rely on Wellington Management Company for all investment management and distribution services. Added to my conviction that indexing was a winning strategy, my powerful itch to expand our narrow mandate provided an irresistible urge to create the first index mutual fund. As I’ve often noted, many firms had the same opportunity, but like the prime suspect in a murder mystery, only Vanguard had both the opportunity and the motive.

2. Soaring Fund Portfolio Turnover. Portfolio turnover has leaped from 17% annually during the 1950s to 108% in 2000. With this change from long-term investing (a six-year holding period for the average stock) to short-term speculation (an 11-month holding period) has come higher transaction costs and far higher tax costs to fund investors. Part of the increase reflects a shift from conservative, even staid, investment committees to individual portfolio managers, who themselves last for an average of but five years. There is no evidence whatsoever that this change has been good for shareholders. (Chart 2) 3. Soaring Turnover of Fund Shares. With the erosion of the industry’s focus on funds with long-term staying power, fund shareholders are turning over their own shares at an unprecedented rate. In the 1950s, share redemptions averaged 6% of assets, an effective 16-year holding period. By 2000, the rate had leaped to nearly 40%, a 2½ year holding period. All of this shuffling around in the chase for performance has resulted in an incalculable—but significant—diminution of shareholder returns. (Chart 3) 4. Soaring Fund Expense Ratios. In 1950, fund expenses averaged just 0.77% of tiny assets of $2½ billion. By 2000, with equity fund assets having grown to a gargantuan $4 trillion, the expense ratio had more than doubled, to 1.65%. Naturally, the rates are lower when weighted by fund assets, but even then the increase (from 0.62% to 1.03%) was 70%. In the face of a 160,000%(!)

he purposeth in his heart, so let him give not grudgingly or of necessity, for God loveth a cheerful giver . . . Being enriched in everything to all bountifulness, make liberal distribution to all. In a far more mundane context I have sought, if inadequately, to meet that spiritual standard. When, five years ago, the United Way of Southeastern Pennsylvania presented me with the Alexis de Tocqueville Society Award for service to the community, I summed up my philosophy with these words: It is especially delightful to receive an honor one has not sought, for I have always believed that the simple act of giving—of one’s wealth and one’s self alike—is its own reward, a reward in its most pristine form. Whatever I may have done to deserve this award, my spirit and my deeds reflect this principle: “For unto whomsoever much is given, of him much shall be required.” (St. Luke did not say expected, mind you, but required.) And we—all of us here tonight— have been given abundance beyond reasonable measure. As Dr. Johnson put it, “beyond the dreams of avarice.” Generosity is indeed our obligation, but more, it is our opportunity. What I am saying, then, is not much different from what I learned from Deuteronomy and from St. Paul. We mustn’t give alms because we want a guaranteed ticket to paradise, but because we know, deep down, that it is the right thing to do.

Consider some of the extremes. At their peak in 1972, equity-oriented funds comprised 93% of fund industry assets. By 1974, a 50% stock market decline and net liquidations of fund shares had reduced total industry assets from $60 billion to $36 billion, a cool 40% decline. Then came the rise of money market funds, bailing out our shaken industry and producing a remarkable $270 billion of assets by 1982. At that point, money funds constituted an amazing 80% of industry assets, leaving equity funds with a residual share of 14%. Then, as long term interest rates moved well ahead of short-term money market rates, it was the bond fund segment that was the industry’s fastest-growing component. At the close of 1986, Bond fund assets of $240 billion actually exceeded equity fund assets of $180 billion. The 33% stock market crash of September-October 1987 contributed to the dimunition in equity fund share. But despite the fact that the full year 1987 saw the market rise, equity flows were negative in 1988, and didn’t return to 1986 levels until 1991, five years in which stocks were at bargain-basement levels. But with each acceleration in the great bull market, the equity fund share of industry assets increased apace—from 30% in 1991 to 40% in 1993, to 50% in 1995. As the cash began to roll in, the equity fund share leaped to 67% in 1998, and by the time March 2000 rolled around, equity-oriented funds laid claim to 72% of the assets of this then-$7 trillion dollar industry.

increased from $2 billion to $3 billion, had fallen back below the $2 billion mark as 1974 began. The strange bedfellows, who had fallen from whiz-kids to goats in just seven years, had a falling out, and my Boston partners mustered the power to fire me as President of Wellington Management Company on January 23, 1974. (Now, why do I remember that exact date?) The vote was 10 to 2, with only myself and director John Neff—then portfolio manager of Windsor Fund, and to this day a legendary contrarian investor—dissenting. If I had within my persona an entrepreneurial spark, that date marked its bursting into flame. Rather than accepting defeat and quietly fading away to another career, I pulled out an idea I had been actively nurturing for five years, and had publicly vetted in another Institutional Investor article in January 1972 (“A Wellington Whiz Kid Grows Older”), indeed an idea that arguably hung in the background of my senior thesis that I wrote at Princeton University in 1951 on the tiny mutual fund industry. The idea, simply put, was that the mutual fund industry would do better for itself if it gave investors a fair shake. The collapse of my career in 1974 presented the opportunity to put in place a new structure that would do exactly that. I sprung my big, indeed rather revolutionary, idea at the board meeting of the directors of the Wellington-managed mutual funds, which, as it happened, had been scheduled to take place the very next day, January 24.

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).

Driven by the long bull markets in both stocks and bonds, the ever-market-sensitive mutual fund industry too has burgeoned, growing at a 17% annual rate since 1986 and increasing assets eight times over. Vanguard’s 26% growth rate since then has multiplied 19-fold. To be sure, we found ourselves in the most rapidly growing segment of the fund industry—the direct marketing (largely no-load) sector— which became the industry’s largest distribution channel in 1996. This growth reflects an increasingly cost-conscious breed of self-motivated investor. Happily, we had sensed this trend years earlier, and were well prepared. For in 1977 the Vanguard funds abandoned their 50-year dependence on stock brokers and made an unprecedented leap forward to no-load distribution. Direct marketing has grown at a 21% annual rate, resulting in an 11-fold asset growth. The runners-up in the growth sweepstakes, growing at a 16% rate, were independent firms offering load funds, largely sold by stock brokers. Their assets grew seven-fold. In a poor third place, growing at just 12%, with but a four-fold asset increase, were the proprietary load funds, managed and distributed by the brokers. Despite the obvious and innate competitive advantage held by broker-sold funds, their notably high costs and notably low returns (not entirely unrelated!) were too much for even their dedicated distribution systems to overcome.

trustees—” must bear their share as well, given the responsibilities they are assigned under Federal and State law. And it is a heavy burden, given not only what they have done but what they have failed to do. Whether affiliated with the fund management company or not, they are serving two masters: The management company and the fund shareholders, and that is the root cause of the problem. Yes, we need entrepreneurs to start fund organizations, and, yes, they have a right to make a profit. After all, that’s the American way. But when that profit is excessive, it creates an unacceptable burden on the returns earned by fund shareholders, who are, after all, the owners of the fund. I am not prepared to argue that today’s fund directors have been, as were the trustee’s of Justice Stone’s era, “relieved of their trusteeship obligation by clever legal devices.” Indeed, their trusteeship obligation clearly exists; the problem is that it is given short shrift. There is compelling evidence that the interests of the managers/marketers are being placed first. To the extent that is true, it suggests that fund directors today “consider only last the interests of those whose funds they command . . . and whose interests they purport to represent.” I’m going to develop my analysis of recent industry trends by demythologizing, if you will, the traditional attributes ascribed to mutual funds—attributes that it would be impossible for anyone to seriously argue prevail today.

1965. But, by the early 1970s, the total-return teetotaler of the old days had become a social drinker. It may not be stretching things to say that by the early 1990s he was on the verge of becoming an alcoholic—comparisonwise, to be sure. It doesn’t really matter whether today’s omnipresent S&P comparison has been fomented by the information overload in this miraculous age of communications technology. Or by the self-styled sophistication of the institutional client, who seems to have a vested interest in frequently changing advisers. Or by the appetite of the burgeoning mutual fund industry—with its daily asset valuations—as funds have become the investment of choice among American families. Or by the overly aggressive marketing of funds. (Have any of the funds you see advertised ever fallen short of the S&P 500?) Relative investment performance—“investment relativism” if you will—is the order of the day. The problem with all of this is not that managers should not be held to a performance standard—of course they should—but that they are held to a single standard irrespective of client objectives, and that the measurements take place during extremely short periods. We might well ask: “To what avail?” Enter “Closet Indexing” Surely it is no service to our clients that many fund managers, caught up in the perception that beating the market each quarter is happiness and losing is misery, seem to use the 500 Index as the mandatory measuring stick for their own portfolios—i.e.

year, international 7 percent). So far in this decade, returns of both have been barely positive, with both U.S. and non-U.S. markets—in local currency terms—delivering only about 2 percent per year. In recent years, however, with the weakness in the dollar, foreign market returns, measured not in local currency returns but in dollar returns, have been unusually strong. While the S&P 500 is up about 75 percent since the market lows reached in January 2003, the EAFE Index is up almost twice that amount—142 percent. Some regional markets have virtually exploded—Latin America funds up 600 percent; emerging markets funds up 300 percent; and China funds up 280 percent. As a result, perhaps unsurprisingly, interest in global investing by U.S. investors has reached a crescendo. During the late 1990s through 2002, for example, investors added some $620 billion to their holdings in funds with a U.S. focus, and only about $45 billion to international funds. But following the explosion in foreign stocks in 2003, investors have added $150 billion to their U.S. funds, but more than twice as much, $420 billion, to their international fund holdings. Last year, in fact, 92 percent of all equity-fund purchases flowed into international funds. My experience tells me to urge a little caution—maybe even a lot of caution—before jumping on the global bandwagon. For what seems to be happening—again!

sign.1) So it is only to state the obvious when I say—as I do, one way or another, in almost every speech that I deliver—the financial markets are not for sale, except at a high price. By excluding investment costs and taxes, data presenting long-term returns in the stock market—whether using the Standard & Poor’s 500 Stock Index or CRSP or the Ibbotson data—reflect the entirely theoretical possibility of cost-free, tax-free investing. Those stated returns, therefore, grossly distort economic reality. When we consider the inevitable costs of investing, reality bites theory. And the reality is self-evident and inescapable: The net return of all investors as a group must fall short of the gross return of the market by the amount of their costs. Beating the market is a loser’s game. Now, 100 long years after Bachelier wrote his paper, this reality has finally taken root, even among financial market participants who are not among the lowest-cost players in the game. Consider the recent paper prepared by Merrill Lynch and BARRA Strategic Consulting Group entitled “Success in Investment Management: Building the Complete Firm.

But he was like a father to me—more like a patriarch, really—and became my loyal and trusted friend, not only the man who gave me my first break, but also my rock, the man who had confidence in me when I had little confidence in myself, the man who gave me the strength to carry on through each triumph and tragedy that would follow. When he died last September, shortly after celebrating his 100th birthday—with his sense of place and sense of humor intact, and with his strong and probing mind still active—I had lost the most marvelous and unforgettable character I had ever met. May God bless you always, Walter Morgan! During the depression years of the 1930s, few young men had entered the investment field, and far fewer the tiny mutual fund industry. When I joined Wellington in 1951 it was a tiny company, and in less than a decade I had become Walter Morgan’s heir-apparent. By the early 1960s, I was deeply involved in all aspects of the business, and in early 1965, when I was just 35 years old, he told me I would be his successor. While diamonds lay before me, the Company was in troubled straits, and Mr. Morgan told me to “do whatever it takes” to solve our investment management problems.

But the fact is that most portfolio managers simply don't spend much time agonizing over the tax consequences of their decisions. Ever since the industry began in 1924, it has essentially ignored the tax issue, and in the "good old days" funds were sold as much on the basis of "looking for more income" as on the basis of total return. (In the 1940s and early 1950s, stock yields averaged 8%, bond yields 2 1/2%. Imagine!) Indeed, the industry often sloughed over the difference between income dividends and capital gains distributions, adding them together to arrive at a "total distribution yield," a practice not legally permitted since 1950. In recent years, as tax-deferred IRA accounts and 401(k) corporate retirement plans have come to the fore, tax considerations have gotten even less attention. In fact, investors in tax-deferred accounts are now the driving force in industry growth, accounting for nearly 40% of the assets of equity funds as a group. Investors in these accounts need burden neither their minds nor their checkbooks with tax issues. But the owners of the other 60% of fund assets do not have the luxury of ignoring tax considerations. Each year, they must pay taxes on the fund distributions they receive. Yet mutual funds do not provide adequate disclosure about the tax implications of their investment strategies, portfolio turnover expectations, and gain realization policies.expenses

Its most baneful effects are not limited to the underprivileged. Drug abuse has probably already touched—or one day will touch—every family in this room. While these problems transcend race, we live in a society in which our nation’s minorities are most heavily affected by poverty, prison, and drugs. Racial inequality is America’s most serious problem, and we have miles to go before we will have created equal opportunity for all. Far too little effort is given to how we will deal with these inter-related challenges. To begin the journey, we must reaffirm in practice the powerful words of Abraham Lincoln: With malice toward none, with charity for all, with fairness in the right as God gives us to see the right, let us strive to finish the work we are in (and) bind up the nation’s wounds. . . Our endangered environment—the food we eat, the water we drink, the very air we breathe—is yet another challenge. We in America are surely doing our share to cause the problem. With 4% of the earth’s population, we consume 26% of the world’s oil, and send its residues spewing out into our air.of

To give the fund shareholder a fair shake, quoting Great Grandpa Armstrong, “the first step must be to reduce expenses.” Industry Expenses Soar Yet industry expenses are not only not being reduced, they are soaring. Since 1980 the annual expense ratio of the average equity fund has risen by more than 40%—from 1.10% to 1.57% of fund assets. It has been documented, well, everywhere. But, the industry takes the position that the cost of fund ownership is declining. Or that’s what the industry’s Investment Company Institute says. What it means is that, according to its rather tortured and convoluted methodology, the cost of purchasing equity funds has, in fact, declined, from 2.25% annually in 1980 to 1.49% in 1997. The industry reaches this conclusion by including sales charges plus expense ratios, and then weighting the results by the sales volume of each fund each year.High

I was recently asked about this issue in a question I received from a Vanguard shareholder, a member of a sort of Internet fan club known as “the Bogleheads.” (It is true!): Do you find that when people donate their money or volunteer their time to those less fortunate, good comes their way? And when people are miserly with their money and not very charitable with their time, do the chickens come home to roost? My response: Much as I’d like to shout amen to that thought, I fear that the rewards for doing right and the retaliation for doing wrong are rarely found—at least in any systematic or causal way—here on earth. We’ll have to receive the rewards in Heaven, if we are too receive them at all. The act of giving should itself be the motive for the deed. And when you give, give with an open hand.modest

, “S&P technology stocks, 14% of the value of the index, 21% of my portfolio; GE, 3.0% of the S&P, 1.2% of my portfolio,” and so on. All with this implicit question: “Is my ‘bet’ (as it is usually described) the right one? Or should I align my portfolio more closely to the index?” There’s a lot of casino capitalism by managers and clients alike going on in investing today, and I suppose “betting”— even betting not to lose—is as good as any word to characterize this over-reliance on the composition of an unmanaged and relatively unchanging market index. In recent years, it seems to me, this strategy has become almost tacitly accepted. Indeed, there is considerable anecdotal evidence that we have gone beyond mere measurement to action, as in “I think Coca-Cola is grotesquely overvalued.to

Investment Return Growth of $1: 1872 - 2001 *Impact of change in price-earnings ratio $0.25 $0.50 $0.75 $1.00 $1.25 $1.50 $1.75 $2.00 Economics and Emotions in the U.S. Stock Market* *Cumulative total return in the stock market divided by investment return from earnings and dividends.1890

And then, late in the twentieth century, something went wrong, a “pathological mutation in capitalism,” in the words of journalist William Pfaff. The classic system—owners’ capitalism—had been based on a dedication to serving the interests of the corporation’s owners in maximizing the return on their capital investment. But a new system developed—managers’ capitalism—in which, Pfaff wrote, “the corporation came to be run to profit its managers, in complicity if not conspiracy with accountants and the managers of other corporations.” Why did it happen? “Because the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.” And so it is. Once an “ownership society” in which direct owners of stock held voting control over corporate America, we have become an “agency society,” and we are not going back.first

All ratios are based on last reported fiscal year accounts as at 31st December and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. As you can see, not much has changed, which is how we like it. Our portfolio companies remain superior to those in the main indices on any of the financial measures of returns, profitability, cash flow, or balance sheet strength. As we indicated last year, we are going to remove the leverage calculation from the table in future as it can be close to meaningless. As you can see, we are not planning to remove it just because it looks bad. On the contrary, this year it is at 22% for our Fund’s portfolio versus 53% for the S&P 500 and 41% for the FTSE 100.companies

The name of the new enterprise was inspired by the Amicable Contributionship of London, founded in 1696, and its name, in turn, was derived from the eighteenth-century definition of contribution—“that which is given by several hands for a common purpose,” an apt name for a mutual company owned by its policyholders. This combination of ownership and service—creating a true mutuality of interest between the owners of a firm and its managers—is not now, nor was it then, the common mode of business organization. But it was an inspired idea for its day and for its purpose. And so began the distinguished history of the Contributionship, the oldest property insurance company in the United States. In a short time, each property it insured displayed a firemark carrying the now-familiar four-clasped-hands (“the scout carry”) mounted on a wood plaque. The company did more than insure; it worked diligently to increase the fire safety of its policyholders and of the city as well. The Contributionship quickly prospered, and the rest is history. It survives—indeed it thrives—to this day, with current assets approaching $300 million.

What flowed from our founding purpose was a simple business strategy: to earn the highest possible returns for our shareholders, taking care to invest their dollars wisely, and to operate at the lowest—all right, as the press would have it, the stingiest—cost structure in our industry. We operate a “tight ship,” with minimal extravagance. We do not provide lavish perquisites, first-class travel, or an executive dining room. We negotiate fees with our advisers at arm’s length, and as a result we pay attractive, fair fees. We don’t waste our shareholders’ dollars on excessive marketing costs. Others in this industry just don’t look at low costs as being very significant. But we are proving a logical and unarguable proposition: other factors held constant, the lower the costs, the higher the returns earned by the investors. Simply put: costs matter. A fourth leadership trait is, I think, caring. With our clients as our owners, it should take no more than an enlightened sense of self-interest to care about them, to provide them with the services they require. There could be little question, then, that a sense of caring in our newly- created institution would be requisite for our success. The spirit of our caring ethic was beautifully captured in these wonderful words by Howard M.Technology:

Market Share and Client Loyalty The very first sentence in the 1994 Harvard Business Review article, “Putting The Service-Profit Chain to Work,” noted, “outstanding service organizations spend little time setting profit goals or focusing on market share.” Nor do we. From the time Vanguard began, my two fundamental rules were: “1) Market share is a measure and not an objective; and 2) Market share must be earned and not bought.” Nonetheless, Vanguard’s market share has grown. And grown. And grown. From 9% of direct marketing assets in 1980, we topped 10% in 1984, 15% in 1988, 20% in 1992, and 25% in 1998, reaching a 29% share in late 1999 (Chart 3). Since 1986, significant market share growth has been achieved by just two firms: Vanguard (+14 percentage points, from 15% to 29%) and Fidelity (28% to 31%, +3 points). In the meanwhile, T. Rowe Price (-3 points, to 5%), Scudder (-3 points, to 2%), and Dreyfus (-14 points to 2%) all tumbled sharply. With a total share of 72% in 1986 and 70% in 1999, the “Big 5” are clearly swapping shares with one another. In fact, of the 25 largest firms in the direct marketing field, 19 have lost market share since 1986, with only six gaining. What can we learn from the success of the two peerless leaders in gathering market share? Only this: There is no single route to success.performance

Even though I have chosen the mutual fund categories dominated by large cap funds with similar volatility characteristics to those of the Index, the capitalizations of the stocks in their portfolios are inevitably somewhat smaller. Nonetheless, during the two decades—which obviously includes considerable “survivorship bias” in favor of the funds—the comparative differences were not large. During the first decade, the survivors actually outpaced the Index by 16 basis points, a somewhat uncharacteristically favorable outcome, only to fall 152 basis points behind during the second decade, a more normal result.1 1 If we compare the decade 1987-1997 with 1977-1987, the top quartile reversion to the market was a slightly larger 6.9 percentage points, with all 44 funds reverting toward the mean, including 35 that fell below it, an even more imposing outcome. The past decade was one in which the average fund fell 2.2% behind the Index.

Rather than holding onto their shares, executives typically sell them at the earliest moment the options can be exercised, too often leaving their shareholders holding the bag. Who’s Responsible? Despite the overwhelming reality of the performance of business executives, corporate directors rewarded them handsomely anyway, so surely directors must bear a heavy share of the responsibility for the problems that corporate America has created for its owners. Too many corporate directors failed to consider that their overriding responsibility was to represent, not management, but the largely faceless, voiceless shareholders who elected them—failed, if you will, to honor the director’s golden rule: “Behave as if the corporation you serve had a single absentee owner, and do your best to further his long-term interests in all proper ways.Report

—in the fund arena is “performance chasing,” looking backward instead of forward in deciding where to invest. Investors who didn’t care for non-U.S. stocks when they seemed cheap seemed to develop a perhaps fatal attraction for them when they got, if not expensive as such, surely far more expensive. In my view, trying to pick winning market sectors,—whether sectors in the U.S. market such as real estate, gold, energy, technology, or sectors in the international market such as emerging markets, China, or Latin America—is a loser’s game. I remain a believer in the broadest possible diversification and intelligent asset allocation between stocks and bonds (depending largely upon one’s age, wealth, income needs, and risk tolerance) and then doing nothing. It’s not the typical case of “Don’t just stand there. Do something!,” but rather, “Don’t do something. Just stand there!”

While our financial resources were meager to a fault, with generous scholarships and jobs (at school and during our vacations) we were admitted to Blair Academy, a wonderful independent boarding school in New Jersey, not far from the Delaware Water Gap. Blair changed my life. At the end of my two years there, despite my slow start in adjusting to its far tougher academic program, I graduated second in the Class of 1947. The masters were all teachers and they were characters; they exuded character; they unfailingly demanded high character of their charges; and they pushed me to the very limits of my abilities. Without Blair, I never could have gained admission to Princeton. Given what Blair did for me, I incurred a huge debt to the Academy, as well as a huge obligation. My debt can be precisely measured in the financial benefits Blair offered me, and I’ve long since repaid that debt in dollars and cents, many times over. But my obligation is infinite. For virtually everything I’ve achieved in life began with my few years there, when a boy became a young man, well-prepared for college, and launched on his long voyage on the turbulent seas of life. When I was invited to join Blair’s Board of Trustees in 1970, I reveled in the opportunity to repay my obligation.its

” Written by senior executives of the two firms—after consultation with as distinguished a list of money managers and powerful fund sponsors as one could possibly imagine2—the study reaches this major conclusion: Management of Embedded Alpha, the frictional costs of running a portfolio, will emerge as an essential contributor to investment manufacturing quality and performance. The Merrill Lynch/BARRA Study For me—and I think for you as investment professionals—the heart of the ML/BARRA study is not its long series of speculations, however intelligent, about the future development of investment management—the business itself, investment manufacturing (their off-putting word); distribution; viable business models; and optimal size. Rather, the heart of the study is its clear articulation of what it calls Embedded Alpha, the frictional costs that detract from the return that can be theoretically produced by an investment portfolio in a frictionless securities market. In a special appendix, firms are urged to “Manage Embedded Alpha, Cut Those Hidden Costs.” The costs are identified in these direct quotations from the study: 1 Taken to its logical conclusion, the theory suggests that the new bare-bones-cost computerized portfolios (often known as “folios”) will represent powerful competition for mutual funds, whose costs are prohibitively high.

Everywhere I go I see hope in our youth—you!—and a spirit of idealism, too. Yes, business is about creativity and productivity, and goods and services and jobs and benefits, and success and wealth and greatness—all of these. But business must also be about ideals, about making the world a better place. You’ve spent two years here studying business, and have been inculcated in the belief that markets work. They do! And that economics is, finally, the language of business. It is! But without virtue, business is a hollow pursuit. In his remarkable book, Business as a Calling, the inspiration for the title of my remarks today, the theologian Michael Novak catalogues three cardinal virtues of business:  “The virtue of creativity . . . the inclination to notice what other people don’t yet see, to act on insight . . . to foresee the needs of others and satisfy those needs . . . intellectual capital is the chief source of wealth.  “The virtue of building community . . . the wealth of all nations . . . more than ever, work toward a common goal is work with others and work for others . . . requiring fidelity, reliability, diligence, industriousness, and especially courage.

Today, it is impossible to overstate the importance of technology in our operations. Our technology expenditures represent some 40% of our total operating costs—more than $400 million in 1999. By way of contrast, we spend less than $15 million on the investment supervision of the $370 billion of mutual fund assets we manage directly—$150 billion in fixed-income securities and $220 billion in equities that track various stock market measures such as the Standard & Poor’s 500 Stock Index—barely 3% of the technology budget. Technology—Finances and Focus While our expenditures on technology can be characterized as real money—or even real, grown-up money—our operating expenses have actually declined in relationship to our burgeoning fund assets. When I gave that stodgy quote to Forbes in 1985, our direct expenses of some $45 million represented 0.41% (41 basis points) of our $10 billion-plus asset base— essentially the figure that represents how much of a shareholder’s investment return is consumed by our direct costs.basis

Early in 1974, the four partners with whom I’d earlier joined banded together to fire me. It was the end of my Wellington career. January 1974, Break #2–A Door Slams . . . A Window Opens But a new career was only months away. Heartbroken when the door slammed at what I considered “my” company, I wasn’t sure where to turn. But a window opened when I recalled an idea I’d been playing with for some years, an idea, in fact, whose genesis may have been in that 1951 thesis that talked about building a better industry. The idea, simply put, was to “mutualize” Wellington Fund and its ten sister funds, making the funds independent of Wellington Management Company, the firm that controlled them and the firm that had just fired me. (The Funds’ Board of Directors was largely independent of the Management Company’s.)continuing

To answer that question, I need only point out that, in all respects save one, the stock market is a gambling casino. In the casino with which we are familiar, gambling is a zero-sum game. One gambler’s loss is another’s gain—until the croupiers rake off their share of the wagers. It is true at the roulette tables and at the racetrack alike. And after the croupiers’ rakes descend, the casino is a negative-sum game. The longer the investor stays in the gambling casino, the greater the certainty that he will, finally, be wiped out. What is different in the stock market casino? Investing in equities is not a zero-sum game, but a positive-sum game. Or at least it has been during most of past history. With the profitability and growth of corporate America, stock prices have risen steadily over the years. Yet each day, investment professionals and amateurs alike are buying and selling stocks with one another, and when the seller wins the buyer loses. So in the stock market, the returns earned by all investors are inevitably average, and beating the market is a zero-sum game. But, just as in the regular casino, it is only a zero-sum game until the croupiers rake off their shares. Then, investors as a group must, and do, fall short of the market’s return.

Where Else Can An Investor Go? This capsule history of the mutual fund industry’s asset mix is, if nothing else, a confirmation of our fundamental character: We are a market-sensitive industry. But it also validates the fact that in all three of the pieces of the basic asset allocation pie—cash, bonds, and stocks—mutual funds are formidable competitors. Just think about it. Where else can an investor go?  For cash, the money market fund puts bank savings accounts to shame. By leaving the traditional—and expensive—active checking accounts to the banks and focusing on large account balances with infrequent transactions, and eliminating all that costly “bricks and mortar,” we provide substantially higher yields. And if you’re worried about the lack of Federal deposit insurance, isn’t it possible that a U.S. Treasury Money Market fund is even safer than a bank deposit?

Make no mistake about it, then: It was speculative return that drove the Great Bull Market. The fact is that, based solely on investment return, $1 invested in the S&P 500 at the outset would have grown to $7—a handsome seven-fold enhancement. But the leap in the P/E multiple alone increased that investment return to a market return of $24—nearly twenty-four times over, 3½ times (!) the hardly inconsequential investment gain. Yes, we had literally never had it so good. Can it happen again? I can’t imagine how. To understand why, let’s take Lord Keynes’ advice and look at the sources of the past returns on stocks and then apply them to the decade ahead. Today, the S&P 500 Index yields not 5% but 1½%, reducing this key contributor to stock returns by fully 3½ percentage points. When we add an assumed 6% earnings growth (corporate earnings, truth told, grow at about the same pace as our economy), the investment return on stocks would be just 7½% per year. Will speculative return add to or detract from this figure?earnings

’ But at least in my view, our society came to measure the wrong bottom line: form over substance, prestige over virtue, money over achievement, charisma over character, the ephemeral over the enduring, even mammon over God.” It’s all too easy for you in our younger generation to look at capitalism as a money- grubbing system in which greedy businessmen, investment bankers, and money managers of hedge funds and mutual funds alike garner unfathomable wealth at the expense of the average citizen who does the nation’s work and does it with neither complaint nor the hope of outsized rewards. And while there is some truth to that—indeed, in the book I express great concern about a two-tier society divided (and hardly evenly) between “haves” and “have nots”—let us not forget that it was the flourishing of true capitalism two centuries ago that has been importantly responsible for the plenty we enjoy in the modern era.

In this age of the portfolio manager, some 1,800 equity funds are managed by a single individual, with the remaining 2,900 run by a “management team,” or a whole series of “portfolio counselors.” This evolution—really a revolution—has led to costly discontinuities. A “star system” among mutual fund managers has evolved—with all the attendant hoopla— although most of these stars, alas, have turned out to be comets. The average portfolio manager now lasts for but five years. 5. Investment Strategy. In 1951, mutual funds focused on the wisdom of long-term investing, holding the average stock in the portfolio for about six years. Today, the 4 The Morningstar categories are based on nine boxes, with three market-cap categories (large, medium and small) set on one axis and three styles (growth, value, and blend) on the other.

While the Quantitative School relied heavily on its capital asset pricing model and the belief that the financial markets were highly efficient, the Pragmatic School relied on the brute evidence of pension fund returns and mutual fund returns relative to the market, and the obvious fact that investment costs were largely responsible for the shortfall. But both schools agreed that owning the entire stock market, as represented by the Standard & Poor’s 500 Index, was a way to capture close to 100% of the market’s annual return. In a world in which the average manager, simply because of advisory fees and transaction costs, could capture only 75% to 85% of the market’s annual return, indexing was certain to be a winning strategy. From Heresy to Dogma Well, what began as the heresy of a few fanatics a quarter-century ago and more has become the accepted dogma of the academic community, individual and institutional investors alike, and even a large number of investment practitioners. Market index strategies, unheard of at the outset, have grown to $6.5 billion in 1981, $235 billion in 1991, and $1.3 trillion(!) in 2001— from zero to 1% to 6% to 10% of the market value of all U.S.stocks

“Serious mistakes,” I indicated, included such errors as investing in funds with spectacular records (“no investor ever went broke by failing to invest in a hot new product”), as well as those persistently at the bottom of the deck; excessive reliance on narrowly-based funds (say, emerging market funds); and using mutual funds for short-term trading. As the stock market bubble inflated, some of these dos and don’ts didn’t seem especially necessary. Now, after the fall, their validity has been reaffirmed. Pillar 2. When All Else Fails, Fall Back on Simplicity. There are an infinite number of strategies worse than this one: Commit, over a period of a few years, half of your assets to a stock index fund and half to a bond index fund. Ignore interim fluctuations in their net asset values.your

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I’ll deal with five of them: Myth 1. That mutual funds are long-term investments. Myth 2. That mutual fund managers are long-term investors. Myth 3. That mutual fund shareholders are long-term owners. Myth 4. That mutual fund costs are declining. Myth 5. That mutual fund returns are meeting the reasonable expectations of investors. I’ll challenge these myths by presenting the realities of how radically this industry has changed over the years, especially in what we might consider the “modern era” of funds, beginning in the mid-1980s, when fund assets first crossed the $500 billion mark. Then, lest I leave you with all problems and no solutions, I’ll conclude with a Golden Rule and Ten Commandments for directors that would help to begin the arduous process of putting the fund shareholders back where they belong: In the driver’s seat of this critically important financial machine.

Simply adding speculative return to (or subtracting it from) investment return produces the total return generated by the stock market. For example, with the current dividend yield of 2 percent, if stocks experience earnings growth at the long-term average of 5 percent over the coming decade, the investment return would total 7 percent in nominal terms. During the coming decade, I actually expect the P/E ratio to change little on balance from the present level of about 16 times. So my expectation for total stock returns over the next decade is about 7 percent per year before inflation. Let’s see how this methodology worked in the past. (Chart 1) By relying on it, decade after decade, over the past century, we can account, with remarkable precision, for the total returns actually earned by U.S. stocks. The investment return on stocks (top line of figures) proves to be remarkably susceptible to reasonable expectations. The initial dividend yield (red bar)—a crucial, but wholly underrated, factor in shaping stock returns—is a known number. The steady contribution of dividend yields to investment return during each decade has always been a positive, only once outside the range of 3 percent to 5 percent. Speculative Return: Impact of P/E Change 0.8% -3.4% 3.3% 0.3% -6.3% 9.3% -1.0% -7.5% 7.7% 7.2% -3.2% 0.2% -10% -5% 0% 5% 10% 15% ? 4.7% 2.0% 5.6% -5.6% 9.9% 3.9% 5.5% 9.9% 4.4% 7.4% 0.8% 4.8% 4.8% 3.5% 4.3% 5.9% 4.5% 5.0% 6.9% 3.1% 3.5% 5.2% 3.2% 1.2% 4.5% 2.

By mid-2017 Binny had begun installing dedicated CEOs across Flipkart, Myntra and PhonePe — a deliberate, if under-reported, succession choreography. He framed it as a personal pivot toward mentoring and investing, a signal that he had mentally exited the operating role more than a year before the Walmart deal closed.

increase in fund assets, that expense ratio increase presents clear evidence that it is not fund shareholders have enjoyed the staggering economies of scale available in the money management field. No, it is the fund managers who have been the beneficiaries. (Chart 4) 5. Inferior Relative Performance. The bottom line: fund investors have not received their fair share of the stock market’s bountiful rewards. That shortfall is easily measured. Over the past 30 years the average surviving equity fund provided an annual return of 0% 10% 20% 30% 40% 50% 60% 70% Total Redemptions Redemptions Excluding Exchanges 39 %* 28 %* Investor Turnover of Equity Fund Shares 7 % 11 % 12 % 20 % 62 % *2000 - Through November, annualized Mutual Funds: Funds vs. Common Stocks Chart 3. 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000E Average Equity Fund Expense Ratio (basis points) Mutual Funds: Cheap vs. Dear Chart 4.

Now let’s assume that we’re fortunate enough to enjoy future nominal returns in the stock market averaging 7 percent per year, roughly what reasonable expectations suggest for the coming decade. (We can talk about that later.) Let’s also assume that the inflation rate will be about 2 ½ percent, leaving a 4 ½ percent real stock market return. If equity fund costs continue at today’s 2 ½ percent rate (and there’s no evidence that they are declining), they would confiscate about 60 percent of that annual real return. But don’t stop there. Compounded over an investment lifetime—say, 50 years—$10,000 invested at 4 ½ percent (let’s make it 4.4 percent to take into account the minimal costs of an index fund) would produce a real profit of $76,100. On the other hand, $10,000 invested at a return of 2 percent (net of that 2 ½ percent cost) would grow by just $16,900 in real terms. Rather than taking the road less traveled by—passively owning the entire market—the investor who travels the traditional road of active management would earn less than 25 percent of a stock market profit that is there for the taking. (The exact figure is 22 percent.)

When we take operating expense ratios into account, however the fund failure becomes self- evident. (It would be even more apparent if we also adjusted for fund sales charges which would have consumed about 0.6% of total return for load funds and 0.4% for load and no-load funds combined.)study:

While, yes, interest rates have tumbled from 13% to 5%, the earnings yield-about equal to the 13% bond yield at the outset-is now only 3.6%-about two-thirds as high as the interest rate (i.e., the ratio has dropped from 0.96 to 0.70). In this context, then, let's examine the source of the market's astonishing near 21 % annual total return during the great, long bull market. Well, 6.0% came from the very high initial yield, some 7% came from earnings growth, and 8% per year came from the increase in the price-earnings ratio alone. How much does this change impact the total? Let's just say that if the price-earnings ratio--a measure, not of reason, but simply of emotion-had remained unchanged, the Standard & Poor's 500 Index would today be reposing at a level, not of 1239, but of ... 345. Almost 1,000 points lower! As we look ahead for, say, a decade, we know-we know-that the future contribution of dividend yield will begin at, not 6%, but 1.3%.better

The bull’s case is exemplified by a recent article in Wired magazine (www.wired.com/5.07/longboom/closed) for July 1997. It is entitled, of all things, “The Long Boom,” with the subtitle “We’re Facing Twenty-Five Years of Prosperity, Freedom, and a Better Environment for the Whole World. You Got a Problem with That?” No, “I got no problem with that.” Who among us could possibly have a problem with “watching the beginnings of a global boom on a scale never experienced before.a

In this context, you should understand that under Federal law, a majority of a mutual fund’s board must be independent of its investment manager. So, while I had lost on Tuesday at one board table, I figured that I had a fighting chance of winning on Wednesday at the other, where my adversaries still had considerable power, but not omnipotence. Whether it was entrepreneurial spirit, foresight, or an extraordinary instinct for self-preservation, I sprang the idea of a new structure for the firm on the fund directors. The idea was simple in concept: the funds would now manage themselves, with an eye solely on the interests of their shareholders, rather than entrust the management role to an external company seeking profit for itself. To do so, the funds would simply acquire the mutual fund activities of Wellington Management Company and operate on an “at-cost” basis. (At then-market prices, the purchase would have had a two-year payback. It would have been a great deal!) Such an acquisition, which would have “mutualized” the mutual funds, would have been a move without precedent in the history of the mutual fund industry.Structure

Corporate America and Democracy Given the constraints of time, I’ll address my remarks this morning largely to the subject of returning corporate America to its owners. Since so few owners hold such great power, all that is required is that they assert their obvious authority. The corporation is the property of its owners, and it is utterly logical that they should be put in a position to have their ownership interests honored. Put another way, I urge a return to corporate democracy. Not everyone agrees! Logical or not, the reverse has been authoritatively argued. No lesser a light than top securities attorney Martin Lipton argues that enhancing shareholder ownership rights to nominate directors and to make proxy proposals could “disrupt the proper functioning of the board and limit the ability of the directors to fulfill their fiduciary duties.” And in an op-ed essay in The Wall Street Journal, Henry G. Manne, dean emeritus of the George Mason University School of Law, argues that “the theory of corporate democracy . . . has long been a standing joke among sophisticated finance economists.” (He names no names.) “A corporation is not a small republic . . . and the board is not a legislature . . . a vote attached to a share is totally different from a political vote . . . the essence of individual shareholder participation is ‘exit,’ not ‘voice’ . . . and they can exit their corporate `citizenship’ for the cost of a stockbroker’s commission.

There’s nothing quite equal to a second chance at life. “Something no man could have dreamed would come his way,” just as Goethe promised. Without that miracle, I would not be standing here today. Since then, providence has continued to favor me. What else could explain that just two weeks ago, FORTUNE magazine stuck again, just as it had a half-century earlier. As if to prepare me for these remarks, its feature article on Vanguard began with the headline, “Say It Loud: They’re Average and Proud,” and concluded, “two (of their original) old ideas, low fees and indexing, make Vanguard the company of the moment.” The story’s final words about what is now the industry’s second largest firm: “If Vanguard becomes No. 1, it would be the ultimate validation of its co-op style management structure, of its low costs, and of index funds too . . . a positively freakish event: A triumph of humility over those vain investors who think they can beat the market.” Yes, boldness can lead to magic.

Mainly they require relentless attention to detail: good products, prompt service, well-trained staff with the power to do a little extra when they judge it right to do so. No wonder firms that send you away with a smile on your face are so rare.” So now let’s see the extent to which mutual fund firms are using technology to send clients away with a smile, with better performance, better products, better information, better communications, better services, better advice, and a better cost structure. (1) Better Investment Performance? Technology has changed the financial markets, and for the better. Markets are cheaper, faster, more transparent, and more automated.the

” The Wired thesis predicted the triumph of the United States and the end of major wars, a truly global market, corporate restructuring, high economic growth, and waves of new technology. A virtuous circle, the article added, would be driven by an open society in an integrated world, a circle in which the Fed finally lifts its foot off the brake, productivity soars, biotechnology revolutionizes agriculture, alternative sources of energy abound, Europe is $0 $10 $20 $30 $40 $50 1974 1977 1980 1983 1986 1989 1992 1995 1998 Mar-01 NYSE Nasdaq The Bubble Inflates and Bursts: Nasdaq vs. NYSE, 1972 - 2001 $47.11 $34.91 $32.60 $21.$1

The strong recovery from the market lows reached a year ago has carried the market cap back to $12 trillion, and we are "back to (or at least toward) normalcy" in valuations. With this rebound, the annual return on stocks since the bull market that began in 1982, despite the ensuing bear market, now totals 13%, surely an attractive outcome. Through the miracle of compounding, those who owned stocks in 1982 and still hold them today have multiplied their capital more than fourteen times over. So for all of the stock market's wild and wooly extremes, long-term holders of common stocks have been well-compensated for the risks they assumed. For such investors, the coming of the bubble and then its going, simply did not matter. Right here, then, there's an important lesson about deciding to press on, regardless . . . not only regardless of the boom, but regardless of the bust, too. Chart - $10,000 Investment in the stock market 1982-2003 But that doesn't mean there weren't winners and losers during the mania—and lots of both. Simply put, the winners were those who sold their stocks in the throes of the halcyon era that is now history—corporate executives with stock options, technology entrepreneurs with IPOs, and the investment bankers and mutual fund managers who sold the high-flying stocks to their clients, charging hundreds of billions in fees for their services.of

Myth #1. Mutual Funds are Long-Term Investments Once, mutual funds were considered investments for a lifetime. The idea was to buy a mutual fund as a complete, diversified investment program and hold it, well, forever—Warren Buffett’s favorite holding period for a stock—much as wealthy families use trust companies and private trustees. But over the years this industry has moved from a focus on sound investment management to the marketing of what have come to be known as “financial products” (I don’t care for the choice of words, but the phrase surely hits the nail on the head!) This trend means, as I recall one firm putting it, “we’re in the ice cream business. We prefer vanilla and chocolate, but if the customers want pistachio-maple-walnut, we’ll give it to them.” This change in strategy does much to explain the creation of the go-go funds of the 1960s, those lamentable “Government-plus” funds and the global short-term income funds of the 1980s (all of which came and now are gone), and of the internet, technology, and so-called focus (20-stock limit) funds of the turn of the century. During the past five years, more than 2000 new equity funds have been formed, most of them designed to capitalize on the public appetite to duplicate in the future the fabulous returns captured in the past by stocks in this so-called New Economy of technology, telecommunications, and science. If history is any guide, few of these funds will be with us a decade hence.

In any event, to put that issue to rest, I present a similar tabulation with the same funds compared with one another. Exhibit III shows how the mutual funds each quartile have regressed toward the mean of the fund group itself rather than the Index. Again, RTM is the order of the day, with the top quartile funds losing 3.9 points of their former 4.7 point advantage. Fully 30 of the 34 top quartile funds reverted. In the bottom quartile, 33 funds improved their relative records and only one failed to do so. The bottom quartile funds reverted upward by 4.1 points, recouping precisely what they had lost in the prior decade. Clearly, RTM is sending investors a powerful message about the futility of evaluating funds based on their past returns. Of course, mutual fund marketers assume—partially correctly—that most investors are completely unaware that today’s top performers are overwhelmingly likely both to be tomorrow’s ordinary participants in the stock market, and to parallel the average of their peers—in other words, that today’s Beau Brummels are tomorrow’s Joe Six-Packs. Indeed, despite the compelling evidence I have presented, fund advertisers consistently hawk the top performers. Believe me, fund organizations know full well that today’s idols have feet of clay.

and foremost, their principals—pension beneficiaries and owners of mutual fund shares. These intermediaries consume far too large a portion of whatever returns our corporations and our financial markets are generous enough to provide, with far too small a portion of these returns delivered to the last-line investors who have put up all of the capital and assumed all of the risks. Curiously enough, what has happened to our system of capitalism is precisely what this university’s great founder warned us about two centuries ago. Hear Thomas Jefferson: “I hope we shall crush in its birth the aristocracy of our moneyed corporations which dare already to challenge our government in a trail of strength, and bid defiance to our laws.” We didn’t do that, and here are nine quick examples—three each from corporate America, investment America, and mutual fund America—that reflect the negative consequences of this change. In Corporate America:  One, the staggering increase in managers’ compensation. CEO pay has risen from 42 times the compensation of the average worker in 1980 to 340 times currently, a 756 percent rise after inflation, while the real income of the average worker has barely kept pace with the cost of living. Long ago, Herbert Hoover, one of our few businessmen to serve as president, put it well: “The only trouble with capitalism is capitalists. They’re too darn greedy.” Imagine what he’d say today.  Two, the rise of financial engineering.

“An institution must be the objective of intense human care and cultivation: even when it errs and stumbles, it must be cared for, and the burden must be borne by all who work for it, all who own it, all who are served by it, all who govern it. . . Every responsible person must care, and care deeply, about the institutions that touch his life.” In an institution, of course, it is real people who must share its values, and real leaders at all levels who must carry out that spirit of caring with human decency and compassion. With caring as our foundation, a myriad of logical consequences followed. To name but two: candor and loyalty. For example, we care about our shareholders as honest-to-God human beings with their own hopes and fears and aspirations, not as sterile dollars or target markets, and address them with candor always—in times good and times bad alike. And we care about our crew (we don’t much care for the term “employee”), another set of human beings, giving them the same commitment of loyalty that they give to the firm. This concept that loyalty must be a two-way street led us, more than a decade ago, to establish a Partnership Plan in which each and every crew member shares in the extra profits we generate for our shareholders. Never forget that a caring leader must also be the servant of both client and crew. This next one may surprise you, but I have come to regard failure as another essential of leadership.

A Much Younger Cousin, A Mixed Pedigree Vanguard, of course, is a much younger enterprise, and its pedigree rather more mixed. We trace our lineage to 1928, when another remarkable Philadelphian, financial entrepreneur and fund pioneer Walter L. Morgan, founded Wellington Fund, one of America’s oldest mutual funds. His company, Wellington Management Company, operated and managed the fund. Like its peers, however, while it was mutual in name, its management was engaged in carving out a profit from the advisory and distribution fees the fund generated. It was the creation of Vanguard in 1974 that changed the operation of Wellington Fund from being a profit-making entity for its operators to one that operated on an at-cost basis, one in which the fund shareholders actually owned the operating company. Flying in the face of industry tradition and practice, Wellington Fund, under Vanguard’s aegis, became a truly mutual mutual fund, now joined by 106 sister funds that compose the Vanguard family of mutual funds. The change in the character of Wellington and its sister funds—from profit to not-for- profit—came when they were brought under the Vanguard umbrella. How that happened is a tortuous and compelling saga, filled with success and failure, joy and sadness, good choices and bad. I will not recount it today, except to say that we began operations as a tiny company with a crew of 28 members, providing only administrative services to Wellington and the other Vanguard funds.

than the rate of 7% for the past 40 years, but I would not bet the ranch on much more than that-and maybe even less. Together, those fundamentals would lead to a market return of 8.3% annually. To do better would require the price-earnings ratio to rise well above its present all-time historic high of 28 times. So, let's playa little game. With an unchanged p-e ratio, we know that the market return ought to be about 8%-perhaps 1 or 2 percentage points more or less. If the price-earnings ratio falls to, say, 18 times, the total return on stocks would be not 8%, but 4%. And if the ratio rose to 71, the total annual return on stocks would be 18%. Chart #6 Here I use 18% because that is the return the market must provide over the next decade to meet investor expectations (if we are to believe what mutual fund investors told a Gallup Poll last autumn). I, for one, can't imagine it. But I should tell you that your afternoon keynoter-a man for whom I have the most profound respect-has suggested that a price-earnings ratio of 50 times would not be excessive, and that even a 100 times(!) price-earnings ratio, "using a simple and accepted formula," in his words, might be justified. (His talk will explain "Why the Dow may quadruple" from here-which it would do in year eight if the annual return on stocks turns out to be 18%. And, of course, he might just be right-but I wouldn't bank on it.

wealth from public investors to corporate insiders and financial intermediaries. When speculation takes precedence over investment, there is always a day of bounty for the few followed by a day of reckoning for the many. Our late bubble was but the latest "extraordinary popular delusion and the madness of crowds—tulips in Holland, shipping in the South Seas, stocks in 1929, the go-go years of the 1960s. It's all of a piece, with the past, as rational expectations were once again replaced by irrational exuberance. Our, well, flexible financial system cooperated in the madness. Aggressive earnings guidance from corporate executives, realized by fair means or foul; manipulation of revenues and expenses, balance sheets; the debasement of accounting standards; public auditors who became consultants to management, in effect, business partners; the "sell-side" analysts of Wall Street, whose recommendations were often shaped by the desire to attract investment banking clients; and the "buy-side" analysts of the mutual fund industry, who put aside their training, experience, and skepticism and succumbed to the heady spirit of the mania. But if there was a single dominant failing of the recent bubble, it was the market's overbearing focus on the momentary price of a stock rather than on the intrinsic value of a corporation. Yet the price of a stock is perception, and acting on that perception is speculation.

11.2%, equal to 87% of the stock market’s 12.8% annual return, a 1.6 percentage point annual lag accounted for largely by fund costs—significantly lower 30 years ago than today. Compounded, the fund return of 2,500% was but 64% of the market return of 4,000%. For the fund investor, who put up 100% of the capital and took 100% of the risk, I do not believe that 64% of the market’s largesse is a fair share. What is more, the average return of these surviving funds surely substantially overstates the reality. More than one-half of 1970’s equity funds (194 of 355) no longer exist, and the records of those doubtless laggard funds is lost in history. The 1970 fund investor, it turns out, had just one chance in 15 of picking a fund that beat the market. (Chart 5) These five trends—the overriding interest of managers in asset gathering and sales promotion, in investment failures and speculation, and certainly in maximizing fee income and arrogating to themselves most of the economies of scale—surely suggest that the interests of fund managers are being placed ahead of the interests of fund shareholders, precisely what the 1940 Act was expressly aimed at preventing. Taken together, soaring investment activity and soaring costs have had a powerful negative impact on the returns earned by fund shareholders. Unless reversed, these trends will continue to harm mutual fund investors in the years ahead.

Anand Nayak, former ITC HR head, tells Open that Deveshwar's greatest strength was articulating a mission framing ITC as a commercial enterprise with the overarching objective of 'putting India first' and creating value for the country. His concept of distributed leadership held that leadership was not concentrated with the top team but required at multiple organizational levels —.

chairman in 1984, and served in that post through 1999. (I continue as a dedicated trustee to this day.) Even as my heart began to fail and during my long siege in the hospital awaiting the transplant, I threw myself into helping to rebuild my old school, to develop a long-range plan, and to restore its reputation. During that era, we’ve added a new classroom building, a new arts center, a new library, and a new girl’s dormitory, and are now building a new student center and gymnasium. At the same time, our endowment fund has risen from a pathetic $900,000 to a reasonable (but hardly excessive!) $54,000,000. Would that these were all my personal accomplishments! Alas, they’re not. Most of the credit goes to the remarkable headmaster who joined us in 1989 and leads the school to this day. Even as with Joe and Rick at the Constitution Center, hiring Headmaster T. Chandler (“Chan”) Hardwick and his wife Monie remains my signal achievement at Blair. With the support of a splendid faculty and staff and a fine alumni body, these two wonderful human beings have invested their lives in making the school that I love among the best in the nation. Now educating remarkable young citizens who will serve as America’s leaders in the new century, Blair Academy is a far better institution today than when I found it (or did it find me?) in 1945, all those years ago. Vanguard I suppose that its fairly easy to leave something better than you found it when it didn’t even exist in the first place.

” In other words, if you don’t like the way your company is being run, just get out—sell to the first bidder, whether or not the price reflects the corporation’s intrinsic value. “Like it or lump it,” however, doesn’t seem a particularly enlightened approach to public policy. Dean Manne’s objections seem to assume that all of those who are interested in embracing ownership rights are “special pleaders with no real stake, activists (whose) primary interest . . . is to facilitate publicity for their own special-interest programs . . . and to interfere with the property and contractual rights of others in order to achieve their own ends,” describing corporate democracy as a “form of corporate fraud.” Though I’m confident that at least some corporate activists have agendas that might not comport with the public weal, I confess that I don’t know quite what to make of such a diatribe. But I know that I have no such agenda. I hold only this simple conviction: Owners should be allowed to behave as owners.center,

2% -10% -5% 0% 5% 10% 15% 20% 8.2% 6.3% 11.5% -1.1% 14.9% 10.8% 8.6% 13.4% 9.6% 10.6% 2.0% 9.3% 7.0% Dividend Yields Have Accounted for Half of the Long-Term Returns on Stocks Market Return (S&P 500) 9.0% 2.9% 14.8% -0.8% 8.6% 20.1% 7.6% 5.9% 17.3% 17.8% -1.2% 9.5% 7.0% -5% 0% 5% 10% 15% 20% 25% 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 1900 – 2010 Avg Investment Return: Dividend Yield and Earnings Growth Oct.1

in 1993, a full decade ago. As a group, alas, our corporate directors have failed to measure up to that standard. Two centuries ago, James Madison said, “if men were angels, we wouldn’t need government.” Today, I would echo that idea: If chief executives were angels, we wouldn’t need corporate governance. Extending this analogy of political systems to corporate systems when I recently spoke to the Business Council, I said that we should avoid corporate governance based on the dictatorship of the CEO. While democracy might not be possible, I suggested, at least we should establish a republic, with the elected representatives of the shareholders fully empowered to assure that the corporation held high the interests of the shareholder, above all competing claims. (The assembled group of CEOs, by and large, didn’t seem to care for the analogy, and there was a rather heated response from the floor.) There is powerful evidence that directors failed to do just that. The result: a raft of misleading corporate financial statements and the grotesquely excessive executive compensation that helped create the stock market bubble and—bubbles being bubbles—its subsequent burst. Yet the directors of corporate America couldn’t have been unaware of the management’s aggressive “earnings guidance.” Nor that management’s focus was on raising the price of the stock, never mind at what cost to the value of the corporation.

that comprise the median number are 18% and 26%. Nor is a mean (average) number much better as seven stocks in the portfolio have net cash on their balance sheets. The average year of foundation of our portfolio companies at the year end was 1933. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2019? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 9% in 2019. The second leg of our strategy is to employ both negative Environmental Social and Governance (‘ESG’) screening (not investing in high ESG risk sectors such as aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account not only the companies handling of ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy and productivity of capital investment.

I recount these personal anecdotes to you, not to brag about the good fortune that has dogged my tracks, but to present a real-world proof of how providence really can help one’s dreams come true. But one’s career is not the be-all and end-all of human existence. Yes, the way we earn our living is often a vitally important part of who we are, and blessed are those who have committed themselves to careers in which they accomplish much both for other human beings and for themselves. But we do not live by bread alone, and the well-rounded life requires other commitments, too. Commitment to Family and Community It should go without saying that we owe our commitment to our families—especially, on this Mother’s Day, our mothers, those saints who nurtured us as we grew to adulthood. As you young men and women begin to move from being members of established families to establishing families of your own, Goethe’s words again strike home. Until you are committed, there is the chance to draw back. But once you commit yourselves to a family, providence will move too, and all sorts of things occur that might never have otherwise occurred. Children, for example! Surely the commitment to forming a new family provides material assistance and spiritual strength that neither husband nor wife could have dreamed would come their way. So, if you propose marriage or accept a proposal of marriage—if that’s still the way it’s done!—do so with boldness and faith.

2 Among the firms named as providing assistance and perspective for the study: Fidelity, Putnam, Mellon, State Street, Oppenheimer, Citigroup, and Massachusetts Financial Services. I hope that you will pardon me if I wonder how carefully they considered its sweeping implications.

Exhibit III: Returns After Costs BHB Study Vanguard Study Index Composite Return 11.8% 12.5% Average Fund Return (before costs) 11.2 12.3% Average Expense Ratio 0.6 1.0 Average Fund Return (after costs) 10.6% 11.3% Difference -1.2% -1.2% The total shortfall was 1.2% annually, reducing the market index return by 10%. Expenses accounted for 83% of their shortfall, and consumed fully 9% of the funds’ average return. As it turns out, moreover, there is a fairly systematic relationship between the cost and net returns of the balanced funds in our sample. Indeed, the gross returns of the 2nd, 3rd, and 4th quartiles are virtually identical when costs are eliminated from consideration. The results are illustrated in the table below. Unsurprisingly, lower costs lead to higher returns. Exhibit IV: Balanced Funds: Returns vs. Costs Costs Quartile Net Return Expense Ratio Gross Return 1st (lowest costs) 12.7% 0.5% 13.2% 2nd 11.3 0.9 12.2 3rd 10.9 1.0 11.9 4th (highest costs) 10.7 1.4 12.1 Average 11.3% 1.0% 12.3% What is more, costs systematically magnified the gross return advantage earned—for whatever reason. Randomness seems an unlikely explanation; perhaps reaching for a higher income yield to offset expenses is traded off against capital return at a net cost. In any event, every 10 basis points of lower expenses accounted, on average, for 20 basis points of enhanced net return.

integrated, Russia comes to have a solid foundation, and, down the road, China becomes the world’s largest economy. In all, “a radically optimistic meme.”2 In hindsight, the only meme that seemed to take hold was the contagious idea that only the sky was the limit for the prices of the “New Era” stocks, and investors better jump on the band wagon…before it was too late. There were, to be sure, some respected investors and investment professionals, made wary by their knowledge of the nature of stock market returns and hardened by their experience in previous bear markets, who spoke out with passion and eloquence, calling the market overpriced. But the prophets were few in number, for the most recent prolonged bear market had come a full generation earlier, in 1973-74, when, the NYSE Index tumbled 50%, and the NASDAQ plummeted 60%. Alas, these warnings went unheeded. As Dickens might have said of the stock market last March, “it was the age of not enough wisdom, it was the age of too much foolishness.” Recognizing the Bubble While I’m hardly, in Dickens’ words, one of the profession’s “noisiest authorities,” just over a year ago, right at the market peak, I did prepare a speech on “Risk Control in an Era of Greed.” I pointed out that, “when reward is at its pinnacle, risk is near at hand.

common sense. “Earth Day” is wonderful. But it’s not nearly enough. For in Theodore Roosevelt’s timeless words: We must treat our natural resources as assets which we must turn over to the next generation, increased and not impaired in value. One more challenge comes from America’s global role. While America has become the policeman to the world, I wonder whether a Pax Americana—any more than an earlier Pax Brittania or the ancient Pax Romana—can long endure in this era of rapid change. We also now confront new forces of evil, terrorists with growing access to nuclear bombs and the dangerous weapons of biological warfare who lurk around the globe and would happily destroy everything we stand for. Our self-defense is essential, but we cannot stint on the resources we must dedicate to mitigating the obvious imperfections in our society. Our endurance as a nation depends not only on our military strength, but on living up to our ideals of democratic freedom, individual liberty, and the right of each one of us to “life, liberty and the pursuit of happiness.” We must be seen, not as a greedy global bully, but as a magnificent city on a hill toward which the world looks, not merely for economic strength, but for moral leadership. Business: Bread and Circuses In the face of all of these challenges, however, the business of America today seems far too focused on business—greed and the accumulation of personal wealth.

The Gotrocks Family Even before you think about index funds, however, think about the eerie nature of our financial system. Using my version of a parable from Warren Buffett’s letter in the Berkshire Hathaway 2005 Annual Report (it’s in the Little Book), here’s how investing actually works: Once upon a Time . . . a wealthy family named the Gotrocks, grown over the generations to include thousands of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game. But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than the other “dumb” relatives. These Helpers convince the cousins to sell their shares in overvalued companies to other family members and to buy shares of undervalued companies from them in return. The Helpers handle the transactions, and as brokers, they receive commissions for their services. The ownership is thus rearranged among the family members. To their surprise, however, the family’s share of the generous pie that U.S.

and any capital gains realized from the sale of securities. Dividends and short-tenn gains are taxable to you as ordinary income; distributions of long-tenn capital gains are taxable to you as long-tenn capital gains." That is proper disclosure as far as it goes. But it doesn't go nearlyfar enough. Portfolio managers, fund sponsors, and distributors know that funds don't pay much, if any, attention to tax concerns. Rather than ignoring this important fact, they ought to call it to the attention of investors. Here's my try at a much-needed prospectus disclosure: "The fund is managed without regard to tax considerations, and, given its expected rate of portfolio turnover, is likely to realize and distribute a high portion of its capital return in the form of capital gains which are taxable annually, a substantial portion of which are likely to be realized in the form of short-term gains subject to full income tax rates." (Some funds might modify the last phrase.) There would seem to be only two reasons that the disclosure of that known fact doesn't find its way into the prospectus: one, inadvertence; two, some sense that it would hurt the fund's marketing campaign by encouraging investors to focus on the negative impact of excessive taxes on their total returns. Whatever the case, I believe that the sentence quoted should be included as a prominent part-if not the opening sentence-of the disclosure of fund tax considerations in the prospectus.

speed of light giant transactions in complex financial instruments that would have been inconceivable in an earlier age, and operating at volume levels undreamed of in an earlier era. For example, shares of U.S. stocks (NASDAQ and NYSE combined) turned over at 135% last year, three and one-half times the 40% rate of two decades earlier. Importantly, without electronic systems and the dispersal of market activity and back-up communications networks that they facilitated, the rapid reopening of our financial markets after the September 11 terrorist attacks would have been impossible. What is more, money managers today have seemingly infinite information at their fingertips. Corporations observe the rules of full disclosure, and a vast community of investment professionals analyze each firm’s financial statements in intimate detail. Soaring transaction volumes, liquidity and information availability—spread among market participants almost simultaneously—have made the markets even more efficient, arguably making it more difficult for skilled managers to ply their trade. Money managers can—and do—compare their portfolio holdings with those of their peers, and their weightings with those of the stock market indexes which the marketplace uses to evaluate them, and fiduciaries can—and do—regularly evaluate their managers on the same basis.

“A Pathological Mutation” But something has gone wrong in the capitalist system itself. It is well-described by journalist William Pfaff as a “pathological mutation” from the classic system, owners’ capitalism—based on a dedication to serving the interests of the corporation’s owners in maximizing the return on their capital investment—to a new system, managers’ capitalism—in which, Pfaff wrote, “the corporation came to be run to profit its managers, in complicity if not conspiracy with accountants and the managers of other corporations.” Why did it happen? “Because the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.” And so it is. Once an “ownership society” in which direct owners of stock held voting control over corporate America, we have become an “agency society,” and we are not going back. For direct ownership has largely given way to ownership by financial institutions, mainly mutual funds and pension funds. While these institutions held only 8 percent of all U.S. stock a half-century ago, today they own some 70 percent—absolute control of corporate America.

cost funds that don’t sell don’t count. Virtually ignored in the ICI methodology, the managers of funds that investors shun nonetheless prosper, even as their shareholders suffer. To the extent that the industry’s overly-generous appraisal of the data, along with its somewhat specious series of definitions, can be regarded as valid, what the data really show is that, quoting from the independent Morningstar Mutual Funds analysis, “the drop has been driven by investors, not by shareholder-friendly mutual fund companies,” and that a few fund families “deserve credit for keeping their expenses down, but one shouldn’t credit the entire industry for the virtues of a few—and for the diligence of investors in seeking them out.” Given the dynamic combination of (a) the increasing importance of no-load funds (sold without commissions); (b) the rapid growth of low-cost market index funds; and (c) the remarkable rise in market share of the industry’s sole mutual mutual fund complex—the unique structure adopted by a firm that operates its funds on an “at cost” basis (you’ll recognize that firm as Vanguard)—the industry’s claim that the cost of purchasing, as distinct from owning, fund shares has declined may well even be valid, as far as it goes. However, it doesn’t go nearly far enough.

There are lots of croupiers in the stock market casino. Fund managers receive substantial fees, and funds incur operating expenses; stock brokers receive sales commissions when investors purchase fund shares through them; investment bankers and brokers receive fees and commissions for executing fund portfolio transactions. Even the Federal Government finds itself among the croupiers, for portfolio turnover generates realized capital gains, and therefore taxes. Given all of these subtractions from the market’s return, the good plan relies on this surprising, if obvious, rule for measuring investment success. The central task of investing is to realize the highest possible portion of the return earned in the financial asset class in which you invest—realizing, and accepting, that that portion will be less than 100%. It is simply a mathematical impossibility—a definitional contradiction—for all investors as a group to reach 100% of the stock market’s returns. Indeed, given the excessive costs of equity mutual funds, it is a mathematical certainty that, over a lifetime of investing, only a relative handful of investors will succeed in doing so by any significant margin, just as we have seen. If this is iconoclasm, so be it. But accepting this reality—that investors as a group will inevitably capture less than 100% of the stock market’s rate of return—is the first step toward a good plan for equity investing.

Alas, ever the optimist, I failed to take into account the power of inertia. Unprecedented extreme moves are rarely the province of a thoughtful, conservative board of directors, especially a board where the stakes are high and the board philosophically and politically—Philadelphia vs. Boston—divided. The idea failed, but I had a fallback plan. We would internalize the business side of the business—operations, administration, legal, and accounting (hardly the entrepreneurial side)—and leave investment management and marketing—the fun side—to Wellington Management Company. The compromise was struck, and I and some 28 souls who trusted me to make it all work moved from Wellington to become full-time employees of the funds—Wellington, Windsor and eight others. I confess to being a bit devious—but only in a worthy cause!—at this point. While I accepted the compromise, I had no thought whatsoever that the structure just put in place would remain intact. Rather— though I said very little about it—I was certain that our future required full mutualization, also running the investment management and marketing activities in-house. Only in this way could whatever entrepreneurial spark I had fully flourish. The first step was to give the new fund-owned company a strong name. (To my horror then—but a blessing in disguise—the fund directors had determined that the Wellington name—except for Wellington Fund itself—would remain with my adversaries.)

But fear can last only so long. In mid-1982, the tables turned and optimism began to return. By the market high in March 2000, the P/E ratio had soared to 35 times, an annual injection of a full 5.4% of speculative return to the 10.3% investment return of the 1981-2000 period. Result: Despite a 20% decline in investment return, the total market return came to 15.7%, the highest for any comparable period in history. Sometimes, emotions overwhelm economics. Does the reversion of the ratio of market return to investment return to near parity mean that stocks are now fairly valued? We don’t know. We don’t know because no one can be sure how far the market pendulum, having swung so far toward greed, may swing toward fear. What we do know is that since emotions dominate the short-term decisions of most investors, the pendulum rarely comes to rest at fair value for any prolonged period of time. Further, we don’t know because, given the strains our economy is facing after the attack on America, there is considerably more uncertainty than usual about the economic returns that lie ahead. Financial Market Returns in the Coming Decade But let’s look ahead anyway, because we may know more than we think. First, we know that the dividend yield component of future investment return will be tiny. While over the long run, the average yield of 4% on stocks has accounted for more than 40% of the market’s investment return, today’s stock yield is but 1½%—not much gas in the market’s tank.

to retain Wellington as fund advisor and fund marketer. But because success, as it were, in the fund field is driven, not by how well the funds are administered, but by what kinds of funds are created, whether superior investment returns are attained, and how effectively funds are marketed, I feared that I had won a Pyrric victory, for our new company was formally prohibited from performing those critical portfolio supervision and distribution functions. In any event, we needed a distinctive name for our firm, and Lady Luck quickly struck again. In mid-September 1974, a dealer in antique prints happened by my office and sold me some prints of naval battles of Great Britain during the Napoleonic Wars. Glancing at the book from which they had been removed, I read the text describing the Battle of the Nile in 1798, where Lord Nelson demolished the French fleet. His dispatch announcing the glorious victory proclaimed his flagship’s name and location: “Vanguard, off of the Nile.” I knew immediately that I had the name for our new enterprise! As 1974 drew to a close, the new Vanguard Group was a tiny company with a proud name, a staff of 28, responsible for only the administration—nothing more—of $1.4 billion of mutual fund assets, and a mutual structure without precedent in the industry—a structure in which the funds would be operated at cost, and solely in the best interests of their shareholders.

In the early years, pension funds accounted for by far the largest portion of indexed portfolios. But during the 1990s and through 2001, index mutual funds have been the driving force. While the rising market has carried pension fund index assets up eight times, since 1990, from $172 billion to $830 billion, the percentage of pension equity assets invested under index strategies has risen only slightly from 20% in 1990 to 23% today. During the same period, assets of index mutual funds have risen eighty fold, from $5 billion to $400 billion, from 2% of equity mutual fund assets to 12%. Truly, we are witnessing the triumph of indexing. Disquieting Cross-Currents But beneath the surface of this triumph lie disquieting cross-currents. In its original incarnation, indexing was a way to bring the wisdom of investment to those who could grasp the merit of complete diversification, buying essentially all of the stocks in the U.S. market, operating without advisory fees and at rock-bottom operating costs, minimizing turnover costs and extra taxes, and hanging on to each stock for Warren Buffett’s favorite holding period—forever. All that was required was that investors accept the self-evident fact that capturing nearly 100% of the 1% 8% 10% 5% 0.1% 0% 2% 4% 6% 8% 10% 12% 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Domestic Equity Indexed Assets as a Percentage of U.S.Assets

points of our $500 billion base—a near-50% decline. We can’t accept all of the kudos for that reduction, however. For our total direct expenses leaped from $45 million in 1995 to well over $1 billion last year. However, soaring stock prices and huge cash inflows from investors carried our assets upward at an even faster rate. Economies of scale in fund management were also a big help. But modern communications and computer technology played a powerful supporting role, and our now 2000-person technology crew managed both the growth in our shareholder base and the increasing complexity of our businesses processes with extraordinary efficiency, economy, focus, and vision. I might add here a word about management’s role in all of this. Despite what I view as the mind-boggling complexity of computers and investment technology, of programs and processes, of bits and bytes, and of Bluetooth and XML, Bob DiStefano reminds me that how we do technology is far less challenging than deciding what we do—our objectives, our strategies, the allocation of our resources. Be that as it may, the record is clear that we’ve been pretty good in both areas. But we realize that we must never ignore the importance of setting intelligent priorities for our technology resources, and the need to have clear business objectives for each project we undertake. I’ll spare you my own pride in what Vanguard’s Information Technology team has accomplished.

 For bonds, there is no viable substitute for the bond fund. A choice of taxable or tax-exempt funds; a quality level to suit every taste (U.S. Treasury, investment-grade, high-yield); a maturity level to fit every risk profile; and the ability to acquire extraordinary diversification without being nickled and dimed (and dollared) to death in buying and selling small lots of individual bonds.  And for stocks, it’s hard to imagine a better concept than a broadly diversified equity fund, holding one hundred or more stocks in every imaginable industry; minimizing individual stock risk; and either retaining experienced professional managers to select and supervise the portfolio or, maybe even better, just owning the entire stock market in a single fund; and operating with remarkable efficiency. Truth told, the only other choices are to pick stocks yourself, or, if you’re in the six-figure or seven-figure or eight-figure wealth category, to hire such managers to pick stocks for you. So there are solid conceptual reasons why American families continue to pour half of their hard-earned dollars into mutual funds. And yet a moment’s reflection on the industry trends that I’ve shown you presents a perverse riddle that, for whatever reason, has made mutual fund investing far less productive than it ought to have been. The obvious “market sensitivity” exhibited by fund investors has not helped them. It has hurt them.

success, a reputation that hangs on despite the tough sledding that has characterized its returns in recent years; and the most aggressive and expensive marketing and advertising programs in the industry’s history. (“If you sell it, they will come,” apparently.) The other leader, by contrast, has spent little on marketing and less on advertising, relying instead on the word-of-mouth recommendations of its shareholders—they are truly our apostles—and conveying our story through the financial news media. (Truth told, there are a few apostles there too!) “Earned and not bought” seems to work just fine. It is our well-deserved reputation for low costs and shareholder service, part of a truly distinctive business strategy, that lets us stand out in a field populated largely of firms that all seem to do the same things, make the same claims, and produce, over time, the same returns; fund returns that are typically driven down by the high costs of acquisition and ownership incurred by their investors. Professor Porter had it right when he spoke to the Investment Company Institute in 1993: “The mutual fund industry has grown fat and lazy, a ‘me too’ industry with most companies stuck in the middle. Only Vanguard has differentiated itself from the pack by having a genuine, unique, sustainable competitive advantage.” He did reassure industry executives, however, by telling them that our “measured, careful, gentlemanly competition” gave them some protection.

When the Walmart transaction was announced, Sachin Bansal stepped out immediately while Binny remained Group CEO until leaving in November 2018, after which he continued on Flipkart's board for strategic direction. The sequencing — Sachin out, Binny stays briefly, then exits — insulated the integration from a sudden leadership vacuum at a moment of intense scrutiny.

buy a 1.5% portfolio position for protection. Since that’s less than Coca-Cola’s 2.0% weight in the S&P 500 Index, I’ll have a good defensive position versus the Index when it takes the tumble it so richly deserves.” Whatever the case, isn’t that philosophy the antithesis of professional investment management? Hasn’t it become the formula followed by a nervous portfolio manager anxious to hold his or her job? Isn’t it the result of the marketing department’s holding sway over the investment department? In each case my finding would be: “Guilty as charged.” Such a “closet indexing” strategy is, in my view, more pervasive than most investors recognize (or have been led to recognize). But, whether it takes place at the margin of a portfolio or permeates it, I’ve never seen it disclosed in a fund’s prospectus. (A cynic might wonder whether fund independent directors and trustees have been fully informed on the subject.) To be sure, so far it largely applies, when it does, to the large-cap managers. Closet indexing is a relatively simple process when the ten largest stocks in the S&P 500 Index represent nearly 20% of the Index, the largest 50 stocks, 50%. Even if it creeps into the small cap side of the business, it seems unlikely to permeate it, since the largest ten stocks comprise just 1.7% of the Russell 2500 Small Cap Index, the largest 50 stocks just 8.2%. That said, the fact is that large-cap strategies dominate the financial markets.

For in the long run, successful investing is not about picking stocks, or picking sectors, or picking fund portfolio managers, but about capturing the returns earned by our nation’s—and the world’s—businesses. The best way to do so is to own a portfolio that holds all of the corporations that comprehend the U.S. stock market, albeit with a global flavor—at, of course, the lowest possible cost. This happens to be the only strategy that guarantees that you will capture your fair share of whatever returns the stock market is generous enough to deliver. (Ditto, but even more so, for the bond market.) Yes, I’m speaking of index funds, a strategy endorsed not only by me, but by the likes of Warren Buffett, Paul Samuelson, Yale’s David Swensen, and virtually the entire academic community. The reasoning, of course, is straightforward. Investors in the aggregate must earn the market’s return. But only before the costs of investing are deducted. After that deduction, investors must lose to the market return by that amount. So the lowest-cost provider of equity and bond portfolios inevitably provides returns that exceed the returns earned by other providers in the aggregate. Compounded over time, that difference is enormous, because fund management fees, operating expenses, trading costs, sales loads, and excess taxes can, over a lifetime, easily consume 80 percent of investment value.

Headstrong, impulsive, and naïve, I found a merger partner—in Boston, of all places— that I hoped would do exactly that. Alas, despite the glitter, I found no diamonds there. The merger worked beautifully for about five years, but the investment managers who were my new partners let our fund shareholders down, the stock market dropped 50%, and the assets we managed plunged from $3 billion in early 1973 to $1.3 billion in late 1974. Not surprisingly, the new partners had a falling out. But my adversaries had more votes at the Company than I did, and it was they who fired me from what I had considered “my” company. What’s more, they intended to move all of Wellington to Boston. I wasn’t about to let that happen. I not only loved Philadelphia, my adopted city that had been so good to me, but by 1974 I had established my roots here, finding unimaginable diamonds, first, in my beloved wife Eve, who was born and grew up here, and then in six wonderful children. We intended to say where we were, and I had a plan to do just that. For when the door slammed, a window opened, and the acres of diamonds I had begun to discover in 1951 were to remain in Philadelphia. Pulling off this trick was not easy. But I was able to parlay a slight difference in the governance structure of the Wellington funds, owned by their own shareholders, and Wellington Management Company, owned largely by my former partners, into a new career—and with it more diamonds than I ever could have imagined.

period of sustained growth that could eventually double the world’s economy every dozen years and bring increasing prosperity for--quite literally--billions of people on the planet . . . that will do much to solve seemingly intractable problems like poverty and ease tensions throughout the world, all without blowing the lid off the environment.” The thesis, as you might imagine, is based on the triumph of the United States and the end of major wars, new technology, a truly global market, corporate restructuring, high economic growth, and waves of technology. A virtuous circle, driven by an open society in an integrated world. As a result, the article continues, the Fed finally lifts its foot off the brake, productivity soars, biotechnology revolutionizes agriculture, alternative sources of energy abound, Europe is integrated by 2002, Russia has a solid economy by 2005, and China develops the world’s largest economy by 2020. In all, “a radically optimistically meme.” (A word I had to look up . . . but failed to find.) Well, of course it could happen . . . but I wouldn’t bet the ranch on it. The U.S. stock market, however, seems to be betting just that way. It is priced for the best of times, and only the best of times. But what of global stock markets--are they a better bet? Alas, ever the skeptic, I’m a bit doubtful of the global thesis: essentially that, since the U.S.

sacrifice—and the satisfaction of helping one’s fellow human beings in need is quite enough reward. I continue to hold those principles high to this very moment. How Much to Give It occurs to me that those of us who have had the good fortune to accumulate some wealth during our lives—through our businesses, or our investments, or our inheritances—ought to be thinking about whether we are nearly generous enough. I inherited nothing but my genes, and perhaps my values and my character, from my forebears. And I created in Vanguard a business that I’ve never owned (it is owned by the shareholders of our mutual funds). But I have earned a substantial annual income, a considerable portion of which I saved, and invested intelligently enough in the mutual funds I created to have built a nice-sized estate. For many years I’ve followed the practice of giving half of my income to charity, including our United Way; our church; hospitals in which I’ve been given loving care; community cultural organizations, especially those which I serve; the schools and colleges that have touched my life and the lives of my wife, six children, and twelve grandchildren; and lots of other worthy causes that seem to merit my support. While giving at the 50% of income level may be rare, even among those with my good fortune, it is not nearly as generous as it might appear at first glance.

holding period for the average fund is just over one year (1.1 years, to be exact). More charitably, on a dollar-weighted basis, the average holding period is about 1.4 years. Either way, today mutual funds are largely focused on the folly of short-term speculation. 6. Industry Mission. Over the past half-century-plus, the mission of the fund business has turned from managing assets to gathering assets, from stewardship to salesmanship. We have become far less of a management industry and far more of a marketing industry, engaging in a furious orgy of “product proliferation.” Our apparent motto: “If we can sell it, we will make it.” During the 1950s, the number of equity funds grew nicely, by about 35 percent. But during the 1980s, the number of equity funds soared by 110 percent, with another 125 percent increase during the 1990s (most of which, alas, were technology, internet, and telecommunications funds, and aggressive growth funds focused on these areas). Since every action leads to a reaction, of course, the 13 percent fund failure rate during the 1950s has also soared. The failure rate is now on track to reach nearly 60 percent this decade. “As ye sow, so shall ye reap.” 7. Costs. Ah, costs! Costs have soared. On an unweighted basis, the expense ratio of the average fund has doubled, from 0.77 percent in 1951 to 1.54 percent last year. (All right, to be fair, when weighted by fund assets, the expense ratio has risen from 0.60 percent to 0.

at that), that’s still quite high relative to the long-term norm of 16 times. So, I think the P/E is unlikely to rise, and could easily decline, perhaps to 18 to 20 times. No one—no one—can be confident about how much investors will pay for a dollar of earnings ten years hence. But if my expectation is reasonable, the resultant easing of the P/E from current levels would create a negative speculative return of about 1% per year, reducing the annual return on stocks to about 6½%. I’m not much for such precision, however, so let’s assume a wide range of returns on stocks in the years ahead, say 4% to 9%. In any event, we’d best all count on a coming era of lower returns in the stock market, and then hope we’re wrong. But I hardly need remind you: Relying on hope is not a sensible investment strategy. What About Bonds? How will these returns compare with those of other financial assets? Bonds are the customary alternative to stocks, and expectations for bond returns over the coming decade are reasonably easy to establish. Again, Keynes’ analysis helps us here, for the investment return on bonds—“forecasting the prospective yield of assets over their whole life”—depends largely on the interest payments they generate. And since bonds have a fixed maturity date, speculative return plays little role over the long- run. Result: A remarkably high proportion of the subsequent ten-year investment return of bonds is explained simply by the current yield.

positions for as long as you live, subject only to infrequent and marginal adjustments as your circumstances change. When there are multiple solutions to a problem, choose the simplest one. Although the stock market’s wild and wooly odyssey since I wrote them makes those words seem an eon away, I believe more than ever in that basic principle: Rely heavily on index funds, and begin with the idea of a 50/50 bond/stock ratio, adjusting the ratio in accordance with your own financial profile. In my book, I noted that this approach was consistent with the philosophy of Benjamin Graham, author of The Intelligent Investor1. This simplicity surely has continued to prove itself. During the past decade, the annualized return on a low-cost index fund modeled on the Standard & Poor’s 500 Stock Index has been 14.4%, while the average general equity fund has earned +12.3%. The low-cost bond fund modeled on the Lehman Aggregate Bond Index has earned +8.0% annually, while the average taxable bond fund has earned +6.8%. These solid margins in returns—2.1% per year for the stock index fund and 1.2% per year for the bond index fund—were highly predictable, for they largely reflect the cost advantage index funds hold over actively-managed funds. Once again, the majesty of simplicity—the broadest possible diversification at the lowest possible cost—has proved itself. Pillar 3. Time Marches On. Time dramatically enhances capital accumulation as the magic of compounding accelerates.

 “The virtue of practical realism . . . common sense . . . paying your dues by getting your hands dirty and facing day-to-day frustrations . . . a strong sense of how the world really works, from the bottom up, gives you confidence in your ideas, no matter how unrealistic others may think them.” Yes, as Dr. Novak notes, we live in a society where realism seems a bit threadbare and outmoded, where what is said to be important is perception, and who knows whose perceptions are “true”? That notion does not please him, nor, most certainly, does it please me. Ever since I started Vanguard more than a quarter century ago, my mantra has been: “If there is a gap between perception and reality, it is only a matter of time until reality takes over.” The Worldly Economists Please realize that the ideal of business as a calling was hardly anathema to the worldly economists of the ages. Years before he wrote The Wealth of Nations, extolling the virtues of the invisible hand of competition and the essential nature of personal advantage and self-love in making the world’s economic system work, Adam Smith wrote The Theory of Moral Sentiments.

Full disclosure must be the order of the day. The problem-and it is a serious one------created by the relatively prompt realization of capital gains is that taxes must also be paid currently. Yet the truly massive value of deferring capital gains taxes seems almost universally ignored. To put it simply: a tax deferred is an interest-free loan from the U.S. Treasury Department, with a maturity equal to the number of years of deferral. Just imagine the value of a ten-year interest free loan even a 25-year loan. Better still, calculate it. In fact, a $1.00 loan repayment deferred for ten years has a present value of 49¢ (a 25-year loan, 15¢). But perhaps as few as 5% of all fund holdings can expect to be held for ten years and gain that 100%-plus extra profit. Today I estimate, very roughly, that mutual funds are carrying total capital appreciation of a cool $600 billion (25% of equity fund net assets), representing a potential nearby liability to taxable shareholders of some $90 billion. An estimated $450 billion of those gains have not yet been realized, but, holding market prices constant, will ultimately be realized and subject to taxes. Some, $150 billion of this appreciation has been or will be realized and distributed to investors and subject to tax in 1997. This mammoth distribution will be comprised of about $100 billion in 10ng-tenn gains and $50 billion in short-tenn gains.

After all, at a 40% marginal tax rate, each dollar I give costs me only sixty cents, and it often goes to organizations that have been the foundation of whatever success may have come my way. Nice as it might be, I quickly add, I don’t expect others to meet that standard. (“Judge not lest ye be judged!”) But as you consider your own giving plans, I would hope that you’d think a bit more about the right portion of your resources you choose to share with others. According to the Internal Revenue Service, the average American family with an annual income of $50,000 makes contributions of some $2,000 per year. At $100,000 of income, gifts average $3,000; and at $500,000, gifts average about $15,000. The first number (4%) strikes me as within the realm of reasonableness; the second as deficient (3%), and the third (3%) as sadly lacking. Note that the percentages actually decline. I believe that they should grow, and faster than income, in concert with our ability to give.ten

1. Tangible Costs . . . management fees and trading commissions. Each dollar given away for, say, management fees is a dollar explicitly detracted from the portfolio net return. 2. Managed Costs . . . unintended risk exposures, tax costs, and Not-Equitized- Cash, an opportunity cost for not keeping funds fully invested. 3. Invisible Cost . . . the adverse market impact of trading and the opportunity cost of delaying trade execution. Result: “Simply put, every incremental basis point increase in rate of return translates into competitive advantage (by which) a firm improves its absolute performance and its ranking relative to its peers.” Thus, what the study calls the Complete Firm, the firm that “will lead the way . . . will diligently seek to minimize these performance detractors.” Thus spaketh, I remind you, not Vanguard/BOGLE, but Merrill Lynch/BARRA. Here is their prescription for curing the disease: “Releasing Embedded Alpha.” 1. Take a Holistic View (whatever exactly that is in this instance). Appoint a single Embedded Alpha champion with the firm. 2. Take an Alpha Inventory. Develop a coherent policy, and review all work processes. 3. Set Priorities. Widen managerial bandwidth. (Again, I confess my ignorance of the term in this context.) 4. Develop a Strategic Agenda that sets goals by which to measure success. 5. Make It Real on the Shop Floor, communicating the agenda and aligning incentives accordingly. 6. Tell the Market.

After leaving the operating role Binny launched xto10x Technologies, a startup-studio-cum-consulting venture meant to compress other founders' learning curves. The move reframed the Bansal playbook as a repeatable method rather than a one-time outcome, and positioned Binny, like Sachin, as an active angel investor in the post-Flipkart ecosystem.

Pradeep Dhobale, a former ITC director, recalls Deveshwar handing him the loss-making ITC Bhadrachalam paper business in 1999 with the words 'I am giving the lives of 2,000 families in your hands. Please take care of them' — with no mention of production, revenue or profit targets.

The secular rate of earnings growth, on the other hand, while hardly certain, is also relatively stable, usually paralleling the growth in our gross domestic product (GDP). Note that, with the exception of the depression-ridden 1930s, the contribution of earnings growth (blue bar) was positive in every decade, usually running between 4 percent and 7 percent per year. Total investment returns, then, have been less than 6 percent annually only twice (in the 1930s and in the 2000s), and only twice much more than 11 percent. Speculative return, however, (green bar) is, well, speculative. It has alternated widely, from positive to negative and back again from one decade to the next. But over the long-run, speculation has neither added to nor subtracted from investment return. In fact, when P/E ratios were historically low (say, below 12 times) they have been highly likely (84 percent probability) to rise over the subsequent decade. And when they were historically high (say, above 20 times) they have been highly likely to decline (87 percent probability), though in neither case do we know when that change is coming. Of course, certainty about the future never exists, nor are probabilities always borne out. But applying reasonable expectations to investment return and speculative return and then combining them has been a sensible and effective approach to projecting the total return on stocks (orange bar) over the decades.

Indeed, in the coming era of likely lower equity returns, the damage will be even more pronounced. If crimes they are, the culprit is clearly the fund manager. For whether privately-held, publicly owned, or a subsidiary of a global financial conglomerate, it is the manager who is the master. So the watchdogs do not bark. And yet aren’t independent directors essential participants in the creation of new funds and the dissolution of those that don’t work? Aren’t independent directors aware of soaring portfolio turnover and the shuffling of managers? Are independent directors even informed that shareholder turnover is soaring, and that industry data inexplicably under-report fund turnover rates by 50%? Don’t independent directors approve the The Odds of Success: Returns of Equity Funds 1970 - 2000 Cumulative Ret. Avg. Annual Ret. Stock Market Avg. Fund Fund Share of Market 4,029 % 2,564 % 64 % 12.8 % 11.2 % 87 % Odds of Selecting a Winning Fund: 1 out of 15 Number of Funds Beginning of Period: 355 End of Period: 161 Non-survivors: 194 Chart 5. Director Compensation Management Company vs. Mutual Fund Giant Bank1 $ 44,000 $ 642,000 Management Company Mutual Fund Fund Manager Giant Brokerage Firm 55,000 400,000 Giant Investment Banker 41,000 286,0002 Large Fund Manager 48,000 363,000 Insurance Holding Co. 46,000 240,0003 Average $ 47,000 $ 386,000 1-Parent of Fund Manager 2-Plus annual pension of $157,500 for 10 years. 3-Plus annual pension of $115,000. Chart 6.

Investors put up 100 percent of the capital and consume 100 percent of the risk; aren’t we entitled to more than 20 percent of the return? Investment vs. Speculation With that background, let me turn to some of the issues of the day in our financial markets, including the triumph of short-term speculation over long term investment, the roots of the crisis in the debt markets, and the role of financial innovation. It is buying and holding businesses that meets my definition of investment, an idea—believe it or not—that I pursued in my Princeton University thesis on the mutual fund industry way back in 1951. There, inspired by the wisdom of John Maynard Keynes, I drew a clear distinction between investment and speculation. Keynes defined “enterprise” as “the activity of forecasting the prospective yield of assets over their entire life.” He defined “speculation” as “the activity of forecasting the psychology of the market. Keynes used no numbers to make that distinction. But in the late 1980s, I did exactly that. I defined enterprise as investment return, the sum of the current dividend yield on stocks plus their subsequent rate of earnings growth.change

One of the key metrics we use to assess ESG risk is RepRisk data which provides a measure of the current reputational risk for each company based on ESG factors and current “hot topics”. At the end of December 2019, the weighted average RepRisk indicator for our portfolio was 21.9, slightly higher than it was at the start of the year but substantially below the S&P 500 index score of 29.3. At the end of 2019 the four companies with the highest RepRisk Indicator scores were: 1. Johnson & Johnson 58 2. Microsoft 57 3. Unilever 46 4. Marriott International 41 Marriott International dropped from 2nd to 4th following no further significant negative news after the data leak at Starwood in December 2018. Microsoft replaced PepsiCo in the list and its RepRisk indicator score rose due to issues surrounding tax planning by technology businesses and using its strong market position against smaller competitors, both negative impacts we don’t assign much weight to as these are part of what makes it a good investment.&

” Reminding my audience that speculation has been around for at least 2,200 years, I quoted the Roman orator Cato: “There must certainly be a vast Fund of Stupidity in Human Nature, else Men would not be caught as they are, a thousand times over, by the same Snare, and while they yet remember their past Misfortunes, go on to court and encourage the Causes to which they were owing, and which will again produce them.” After examining the stock market metrics in March of 2000, I concluded: “So, let me be clear: You can place me firmly in the camp of those who are deeply concerned that the stock market is all too likely to be riding for a painful fall—indeed a fall that may well have begun as I began to write this speech ten days ago. Viewed a decade hence, today’s stock market may just be one more chapter in “Extraordinary Popular Delusions and the Madness of Crowds.” 2 “What is a meme?,” you ask. So did I. The answer: “A contagious idea that replicates like a virus, passed on from mind to mind. Memes function the same way viruses do, propagating through communication networks and face-to-face contact between people . . . the basic unit of cultural evolution.”

87 percent, a lower, but still staggering, increase of nearly 50 percent. Whichever figure you like, this rise in costs is a major negative. Despite the quantum growth in industry assets since 1951, managers have arrogated to themselves the extraordinary economies of scale available in the field of money management, rather than sharing these economies with fund owners. Money managers—especially the giant financial conglomerates that now own 40 of the 50 largest fund organizations—are all too eager to focus on the return on their own capital rather than focus on the capital they are investing for fund shareholders. One more big negative for this industry.serious

I’m speaking, of course, of Vanguard, the little company that I founded all those years ago, a company started by accident and begun as an experiment. The legends about Vanguard’s creation happen to be true. Yes, in January 1974, I was fired from my job as chief executive of Wellington Management Company. Yes, I then presented a plan to the directors of the Wellington-managed mutual funds under which I would remain as their chief executive, and the funds would retain their own operating staff. Yes, after months of tussling, the directors approved that initial plan, and Vanguard was incorporated on September 24, 1974. (And yes, I picked that name out of an old book of Great Britain’s naval history, where I learned for the first time of Lord Nelson’s flagship at the Battle of the Nile in 1798; it was HMS Vanguard.) The creation of that unique new structure led to: (1) the establishment of a new form of governance in the mutual fund industry, a mutual structure in which the interests of fund investors would take precedence over the interests of fund managers and distributors, in constitutional terms, a governance “of the investor, for the investor, and by the investor.that

At an annual return of +10%, the total value of the initial $10,000 1 Benjamin Graham’s “standard division” was 50-50, an equal investment in bonds and stocks. Since his classic book was published in 1949, this allocation baseline has far more patina than mine. 1. Investing is Not Nearly as Difficult as It Looks 2. When All Else Fails, Fall Back on Simplicity Average Annual Returns, 1991-2001 12.3% 8.0% 6.8% 14.4% 0% 4% 8% 12% 16% S&P 500 Index Average Equity Fund Lehman Agg.Fund

But the managers of these giant investment pools—agents, whose duty is to represent the interest of the pension beneficiaries and owners of mutual fund shares who are their principals— have too often put their own interests first, consuming far too large a portion of whatever returns our corporations and our financial markets have been generous enough to provide, with far too small a portion of these returns delivered to the last-line investors who put up all of the capital and assumed all of the risks. An Ancient Thesis It is a curious fact that my new book echoes in so many ways the principles that I set forth in my senior thesis at Princeton University in 1951. That thesis—and all that followed— depended on an incredible stroke of luck. In December 1949, in Princeton’s Firestone Library, I happened upon the year-end issue of Fortune magazine and learned for the first time that something called “the mutual fund industry” existed. When I saw the industry described in the article as “tiny but contentious,” I knew immediately that I had found my thesis topic. Completed in the early spring of 1951, it was entitled “The Economic Role of the Investment Company.”

It is often best if things do not come too easily in this life. Surely, when I was fired in 1974 from my job as the chief of the mutual fund company I had joined in 1951, I had somehow failed. But out of the ashes of that painful experience came the Phoenix that is “in the vanguard” of the mutual fund field today. And failure seemed to plague our every early step, too. We experienced net cash outflow from our new firm’s funds for eighty consecutive months— think of that!—but we learned and we grew. If you must fail, then you must fight. Persistence was essential in our battle, for it was to take time to put our corporate structure and our business strategy into full flower. The deck was stacked against us at the outset, as our perhaps properly cautious directors were unwilling to create this mutual structure de novo. In 1975, we were allowed only to administer the operational, legal, and shareholder record-keeping affairs of our funds.in

In a remarkable manipulation of financial statements, corporate earnings are managed to meet the “guidance” that these executives give to Wall Street, quarter by quarter. Two of the prize tools for earnings shenanigans: (1) mergers that are made, not with a sound business rationale, but because of the consequent opportunity to manage “pro forma” earnings by creating a veritable “cookie jar” of reserves, to be drawn on at will in order to present a rosy, but false, picture of corporate growth; and (2) arbitrarily raising the assumptions for future returns on corporate pension plans, even as prospective returns eroded. Just think of it: In 1981, the 13.9 percent yield on the long-term U.S. Treasury bond was twice the 7 percent return projected for corporate pension funds. Currently, despite the fact that the bond yield has tumbled to 4.7 percent—65 percent lower—the projected pension return is now 8.5 percent, actually 20 percent higher.the

represents 40% of the value of the $20 trillion world stock market, a fully diversified portfolio, invested 40% in the U.S. and 60% in Europe, Pacific and Emerging Markets, should provide the highest future “risk adjusted” returns. (Risks should be lower because global markets tend to fluctuate in different magnitudes, at different times, than U.S. markets.) But here history cannot help us very much. In the 1970s and the 1980s, for example, U.S. investors in foreign stocks earned returns of 17% per year versus 11% in the U.S.--without much difference in volatility risk. Precedent? Hardly. Precursor? No. So far in the 1990s, U.S. stocks are up 17% per year, foreign stocks up just 5%, and no one can predict which pattern, if either, faces us in the years ahead. To buttress the skeptical case, foreign returns earned by U.S. investors are heavily influenced by changes in the value of the U.S.and

where should they be placed? Who would dare to suggest that barriers should be placed in the way of the right of shareholders to elect as a director anyone they wish to serve as their agent? That owners cannot compel management to be responsive to their demands? That owners must relinquish their right to determine the compensation that executives receive from their company? Aren’t these among the essential rights of ownership? Clearly, they are the rights of the 100% owner, who brooks no interference with his will. And any manager who flatly refused to consider the views of a 50% owner, or even a 20% owner, would soon be looking for another line of work. What about a dozen institutions, each holding a 3% interest and sharing a particular viewpoint, or wishing to nominate a director? Where does the proverbial shovel break? And does the argument that it might break when no single shareholder owns more than, say, 0.10% of the shares justify depriving these shareholders of the same rights? Not for me it doesn’t. For I believe, after Churchill, that corporate democracy “is the worst form of government . . . except for all those others that have been tried from time to time.” (Including, I hasten to add, those that have been tried in the recent era.) The legendary Benjamin Graham long ago put his finger on the problem. In the early editions of The Intelligent Investor, he had some important things to say about stockholder- management relationships.

I should note that differences in asset allocation policy among these balanced funds accounted for some moderately significant differences in total return; i.e., four of the funds had significantly higher strategic equity exposures. However, when risk (measured by standard deviation) was taken into account, only the low-quartile expense group distinguished itself. Specifically, the risk-adjusted relative returns (using the Sharpe ratio) of the three quartiles with higher expenses were all 6% below average in risk- adjusted return, with the low-expense quartile 17% above average. (The average Sharpe ratio was .each

I picked a name borne partly out of Duke-of-Wellington- era British battle history, partly out of my lifelong love of the sea, and partly out of the conviction that we were truly onto a new and better way of running a mutual fund complex. It was, of course, the name “Vanguard.” After heated debate, the Board approved the name. “The Vanguard Group, Inc.” was incorporated on September 24, 1974. By this time, the bottom of the bear market was at hand, and our assets, which had fallen from the $3 billion peak, through $2 billion, were down to $1.4 billion—a decline of more than 50%. And hard times were to face us for eight years, until the summer of 1982, when the great bull market, that I must credit for the lion’s share of our growth, began. That bull market, unprecedented in financial history, remains intact this today. The hard times we faced were reflected in tough financial markets, magnified by the poor performance of Ivest Fund and Wellington Fund, although Windsor, under John Neff’s aegis, performed admirably.still

Magic will follow you, just as over the past 44 years, it has followed me and Eve, and our six children and twelve grandchildren. Commitment to our neighbors and our community is also vital. In this increasingly individualistic age, community spirit—once exemplified by the barn-raising, the quilting bee, the fence-mending—seems almost an anachronism. But a spirit of cooperation and togetherness is today more important than ever, especially in our urban areas where enormous wealth and grinding poverty exist side by side, and where, paradoxically, both extremes seem to lead away from the kind of community spirit that is at the core of the civility that makes community living so worthwhile. I am not at all embarrassed to mention the constructive role of religion in fostering these higher values. While I won’t dwell now on the Christian values I cherish so deeply, I would note that virtually all religions preach the existence of a supreme being, the virtues of a Golden Rule, and standards of conduct that parallel the Ten Commandments. We thrive as human beings and as families, not by what faith we happen to hold, but by having faith, faith in something far greater than ourselves.

Large-cap stocks account for roughly two-thirds of the assets of all equity mutual funds, and an even higher proportion of institutional assets. And closet indexing may well be having an impact on stock returns. While I’d never ascribe causality to any of the myriad factors that affect the price of a stock, it seems more than coincidence that so far in 1997 the largest gains among the blue chip stocks whose capitalizations dominate the market have come to those stocks in which mutual funds have the smallest relative positions. Yet the five largest stocks in the 500 Index most underowned by mutual funds are up almost 50% so far this year, compared to an average gain of roughly 30% for the remaining 495 stocks. Put another way, could it be that active managers, in their passion to compete with the passive Index, are primarily responsible for driving up the price of the underowned large stocks in the Index, giving it, over the past three years, the most formidable record of outpacing active fund managers in the history of the Index, surpassing 90% of equity funds? Are managers forcing their portfolios to become more Index-like, so as to avoid serious shortfalls in the quarterly comparison “sweepstakes” (another word from the world of gambling)?are

The value of a corporation is reality, and acting on that reality is investment. When executives are paid for raising the price of their company's stock rather than for increasing the value of their company's business, they don't need to be told what to do: Achieve strong, steady earnings growth and tell Wall Street about it. Set "guidance" targets with public pronouncements of your expectations, and then meet your targets— and do it consistently. First, do it the old-fashioned way, by increasing volumes, cutting costs, raising productivity, developing new products and services. But in a competitive economy, these targets are not easy to meet. So when you can't meet them by making, you meet them by counting. Push the accounting numbers to the edge—and sometimes beyond. Undertake mergers, not for business reasons but because of loopholes in accounting rules that allow such transactions to provide a short-term boost to earnings. And when all of that isn't enough, cheat. And, as we now know, a number of large firms did exactly that. Owners Capitalism Becomes Managers Capitalism What we've witnessed is a profound shift from traditional owners capitalism—in which the goal is to provide those who invest their capital with a fair return—to managers capitalism—in which major portions of that return are diverted to corporate executives.

Nor that dividends were lowered in order to provide more capital for unwise expansion. Nor that the estimated future returns of 9% to 10% or more on the company’s pension fund were, simply put, “pie in the sky.” Nor could directors possibly have been unaware that it was management that hired the consultants who recommended to the compensation committee higher compensation for that very same management, year after year, even for so-so accomplishments—or worse—in building the business. Nor that shares acquired by executives through stock options were sold as soon as they vested. Nor that the company’s accounting firm was receiving consulting fees many times the amount of its auditing fees, substantially vitiating both its independence and its integrity. And all those director “nor that’s” describe only the major aberrations in the barrel of capitalism. Surely it is fair to say that it is our corporate directors who should bear the ultimate responsibility for what went wrong with capitalism in corporate America. Oh, No They Shouldn’t!

But as long as there are believers in witchcraft, so the purveyors of witches’ brew will create elixirs and offer panaceas—engendering costly, counterproductive investor choices that inevitably come to grips with yesterday’s realities, not tomorrow’s. No study exists that suggests the opposite conclusion: that the very few long-term winners that have emerged (usually through highly superior returns in their early years when they have very small assets and few shareholders) can be selected in advance. But perhaps there is a better way to win the game of seeking superior performance than picking the top-performing funds in advance. So let us turn to a second category of RTM, and another reflection of Sir Isaac Newton’s revenge on Wall Street. 2. RTM in Stock Market Segments If the large cap growth and value mutual funds (used for my earlier examples) must provide short-term returns that parallel those of the stock market, but over the long run must fall significantly short, what about concentrating on stocks in selected segments of the stock market that may have characteristics that lead to superior long-term returns? Alas, there seems to be no systematic segment bias that has endured over time. RTM seems consistently to turn even what often appear to be long-term secular trends into mere cyclical phenomena, albeit often of considerable duration.

There is an obvious—and optimal—way to closely approach this 100% target: Simply own the market. It is easy. An all-stock-market index fund, in substance, owns shares in every publicly held business in America, and holds it for as long as the business exists. By slashing the croupiers’ take, such ownership is available at extremely low cost. There is no advisory fee, for there is no adviser; no sales charges, for there need be no broker; nominal fund transaction costs, for there is almost no portfolio turnover; with so little turnover, few realized gains and minimal taxes. It is fair to say that the all-market index fund is the croupier’s worst nightmare. And, therefore, the investor’s sweetest dream The simplest of all approaches to equity investors, then, is to invest solely in the shares of a single all market equity index fund—just one fund. It is a good plan. And it works. But, I’m a realist. I recognize that in the real world, lots of all-too-human traits get in the way of a simple, all-encompassing index fund approach. “I’m too smart for that;” you may think. “Even if the game is expensive, it’s fun.” “It can’t be that simple.” These are the all too common refrains in the minds of investors—am I speaking for you?—who choose to pursue the conventional strategy of relying entirely on actively-managed funds to implement their investment strategies. “Hope springs eternal,” as Alexander Pope reminded us.breast;

While these might seem rather meager credentials, that structure set in motion all that was to follow. We quickly went to work to expand our mandate. Ignoring the limitations in our charter, we created the world’s first index mutual fund, and then the industry’s first targeted maturity bond funds, now the industry standard. We eliminated the seller-driven broker-dealer distribution force that had marketed the Wellington funds for nearly half a century, replacing it with our own buyer-driven “no load” system. By mid-1977, with our fund assets still below $2 billion, each of the critical elements of today’s Vanguard was not only in place, but set on a firm foundation. We had built it. Now we would test our thesis: “If you build it, they will come.” Our innovation, our structure, our strategy, our faith in stock indexing and in disciplined bond management, our over-bearing focus on low cost, and our attention to serving the needs of our clients were what we built, and millions of investors came. Year after year, unremittingly, our market share of industry assets increased, and our fund assets now total $560 billion. The Vanguard Experiment has worked.

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.

My idea was simple. Why should our mutual funds retain an outside company to manage their affairs—that was, and still is, the modus operandi of our industry—when they could manage themselves and save a small fortune in fees? Truly mutual mutual funds, as it were. The battle was hard, with the Fund Board almost evenly divided, but this new structure finally carried the day. I had named our new company after HMS Vanguard (Lord Nelson’s flagship at the great British victory over Napoleon at the Battle of the Nile in 1798), for I hoped it too would be victorious in the mutual fund wars. However, my idea suffered a setback when the Fund directors allowed Vanguard (now owned by the funds) only to handle the administration side, responsible only for the Fund’s operating, legal, and financial affairs, when we began in May 1975. The other two—and far more critical—sides of the mutual fund triangle, investment management and marketing, were to remain with my rivals at Wellington Management.

The fact is that it is the fUndamentals of dividends and earnings growth, not speculative changes in the price-earnings ratio, that create market returns in the long run. Never forget that essential fact! Nothing could be clearer from this chart comparing fundamental returns with market returns for the past 40 years. Over this long period, dividends and earnings growth averaged 11% per year, and the market return averaged 12%. If you are a long-term investor-and if you are a short-term investor, I have no wisdom to offer you-you should expect far lower returns in the years to come. However, no matter what the markets give us, my conviction remains steadfast that common stocks should remain the principal asset class in a long-run investment program. If your own program was soundly balanced before the bear market-as it should have been-and you were strong enough to resist the temptation to sell stocks at the bottom of the bear market, there should be no need to change the balance now. Fourth simple principle: Stay the Course.

The Perversity of Asset Exposure Think again about the figures I mentioned earlier. The industry’s peak exposure to equities came in 1972 (94%) and in March of 2000 (72%). On the first occasion, a 50% stock market decline was about to begin; on the second occasion, a 40% decline was soon to follow. Despite the nice recovery from the September 21, 2001 low, stocks today remain 30% below their 2000 high. And it is not at all clear, to me at least, that those earlier lows will not be surpassed. So, too, when investors had the chance to lock-in bond fund yields at an attractive 9% in the late 1980s and early 1990s, investors were deserting bond funds in droves. And with yields averaging 6% in 1998 and 2001, bond fund cash inflows were higher than almost ever before in history.

It ignores the fact that the heavy cost of portfolio transactions is a major “cost of fund ownership” which probably—the industry is tight-lipped on this subject—adds up to a full percentage point to fund costs, raising the total annual cost to as much as 2½%—the very number I used earlier in my example of a $10,000 investment compounded over 40 years. Is There Price Competition? There are perhaps 700 mutual fund managers. At least 50 of them have the scale and resources to compete on every front in the mutual fund industry wars. In most corners of the capitalistic marketplace, the result would be fierce price competition to reduce prices. But, as the record shows, there is plenty of competition to increase prices. Competition to reduce prices is conspicuous by its absence. To say the very least, the industry disagrees with that conclusion. The official position of the ICI: “Let there be no doubt in anyone’s mind—mutual funds compete vigorously, based on price.” It is an absurd—I would argue, irresponsible—position. If there is vigorous price competition, how can the industry explain the fact—buried deep (and without comment) in the Investment Company Institute analysis of the costs of fund “ownership”—that the lowest cost 10% of funds have raised their direct expenses from 0.to

It took nearly three long years for us to develop into a full-fledged fund complex, providing not only administrative services to the funds, but distribution and investment services as well. And two more years were to pass before the new enterprise began to grow. But ever since 1981, our path has been one of unremitting growth—indeed the highest growth rate in the mutual fund industry. Mutuality—The Rock Foundation Suffice it to say that mutuality is Vanguard’s most distinctive characteristic, the rock foundation upon which all that we have accomplished depends. But without Dr. Franklin’s angels—energy and persistence—sitting on our shoulders, we never would have been able to form the new enterprise, nor to establish its character, nor to build it to its present substantial size. With assets of the Vanguard funds now exceeding $575 billion, we have become the second largest fund complex in the world.

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

However, I won’t spare you the results of the study conducted by Information Week a few months ago, in which we were ranked #40 among the 500 leading IT innovators. Indeed, in the Banking and Financial Services Category, we were ranked #7 among the 43 top firms, only two of our mutual fund peers even made that list, ranking #13 and #25. What is more, we earned gold medals in each of four designated categories: Application Development, E-business, Customer Management, and Business Processes/ERP. So, eight years after that imaginary Forbes quote that I used in 1992 to illustrate the abrupt change required in our technology priorities—from complacent also-ran to clear leader—we can fairly be said to have reached our ambitious goal. This seems only poetic justice, for the ship’s motto of HMS Vanguard—a name that has persisted in the British navy for more than two centuries—is “leading the way.Technology

Indeed, our considerable excesses are all too reminiscent of the bread and circuses that presaged the decline and fall of the Roman Empire 17 centuries ago. Here’s the way the head of one of America’s largest entertainment and media companies looks at the corporation he leads: We have no obligation to make history. We have no obligation to make art. We have no obligation to make a statement. To make money is our only objective. While his company’s stock hasn’t done so well of late, he, of course, is doing fine, having banked a total compensation of $673,645,000 during the past five years. So much for bread, as it were. As for circuses, one need only observe the stock market tumult on CNBC, or the garish eight-story NASDAQ MarketSite Tower displaying stock prices in Times Square on the world’s largest video screen, and wonder whether it isn’t casino capitalism that is now astride the saddle and riding mankind. Wouldn’t our nation be far better served if American business turned its focus from bread and circuses toward a broader view of its responsibilities? Yes, of course the issues I’ve discussed seem intractable.own

stock market’s annual return was an achievement earned only rarely and inconsistently by active managers, who were in any event almost impossible to identify in advance. The wisdom of index investing for the long-term was simple. It was straightforward. And it did exactly what it promised. But the upsurge in mutual fund indexing in recent years has not been based solely on the wisdom of investing. It has also been based on the folly of speculation. Increasingly, and to an astonishingly unrecognized extent, indexing is being used, not to match the market but to beat it. Long-term ownership of the stock market as a whole is apparently not good enough. A whole variety of new index funds have been designed as engines to enable investors to capture superior returns. In some cases, the funds are based on indexes representing various styles or sectors of the market (small-cap growth indexes and large-cap value indexes, for example) In other cases, the funds are based on traditional broad market indexes (Standard & Poor’s Depository Receipts—Spiders—for example), trading vehicles structured for short-term speculation rather than long-term investing. In still other cases, by a combination of both—for example, the technology-driven NASDAQ Qubes and the i-shares that index the South Korean stock market. In my view, owning the market and holding it forever is the ultimate strategy for winners.

The second component, earnings growth, has little short-term visibility as we work our way through a serious recession in an uncertain economic environment. Corporate profits are tumbling in 2001, and forecasting 2002 is an exercise in guesswork. But the earnings of American corporations are likely to be somewhat higher in 2005 than in 2000, and almost certain to be much higher in 2010. Agree or disagree with my conclusion, that’s what the serious investor should be thinking about. We also know that over the long term, the after-tax earnings of U.S. corporations have grown apace with our population and our productivity, and at a remarkably similar rate. Since the end of World War II, for example, our gross domestic product has grown at a rate of about 7%; so have corporate profits. Looking ahead to the coming decade, a continued—if optimistic— earnings growth rate of 7% plus a dividend yield of 1½% would bring the investment return on stocks to 8½%. It is these economics that will drive the market.

During the more quiescent years of the 1960s, just 28 funds out of but 200 didn’t survive the decade, an acceptable fund failure rate of 14% for the decade. During the 1970s, in the inevitable hangover that followed the wild spree of the earlier decade, 297 funds, including most of the go-go funds, gave up the ghost, and the failure rate soared to an astonishing 62%. Thus cleansed, the industry was more sedate during the 1980s, and the rate receded to 21%. But despite the great bull market, fund failures accelerated during the 1990s, to a surprising 55% for the decade. In the past two years alone, an estimated 450 funds have disappeared. Clearly, too many funds have been formed with the principal purpose of being sold to investors. Often lacking durable investment principles and doomed to performance failure, they were born simply to die. If in the first decade of this century the failure rate of the last decade of the previous century holds, more than, 2300 of today’s 4500 funds won’t be around in 2010.fund—from

And whether we like it or not, benchmark risk—how the manager performs relative to the chosen standard—has replaced, well, real risk—how much the client can lose—as the relevant concept. In these more liquid, volatile markets, electronic technology has sharply reduced the costs of each transaction. Despite these lower unit trading costs, however, total trading costs have actually risen because transaction volume has soared by an even larger magnitude.2000

You may be surprised to learn that in that remarkable book he called for “reason, principle, conscience, the inhabitant of the breast, the great judge and arbitrator of our conduct, who shows us the real littleness of ourselves, the propriety of generosity, of reining in the greatest interests of our own for yet the greater interests of others, the love of what is honorable and noble, the grandeur and dignity of our own characters.” Adam Smith again, here the apostle of virtue. Joseph Schumpeter saw a similar spirit. Fully 90 years ago, he described for us the motives of the successful entrepreneur: “The joy of creating, of getting things done, of simply exercising one’s energy and ingenuity . . . the will to conquer, the impulse to fight, to succeed, not for the fruits of success, but for success itself.” In my own calling, those passions continue to excite me, even as I speak to you this very morning. And John Maynard Keynes followed suit, reinforcing my view that all of these gigabillions of numbers that fly around us are only numbers, quantities on a scoreboard that are only one measure—and, truth told, hardly the best measure—of an enterprise. Keynes emphasized that it was the merest pretense to suggest that an enterprise is “mainly actuated by the statements in its own prospectus, however candid and sincere . . . based on an exact calculation of benefits to come.and

industry bakes each year—all those dividends paid, all those earnings reinvested in the business—100 percent at the outset, starts to decline, simply because some of the return is now consumed by the Helpers. To make matters worse, while the family had always dutifully paid taxes on their dividends, some of the members are now also paying taxes on the capital gains they realize from their stock- swapping back and forth, further diminishing the family’s total wealth. The smart cousins quickly realize that their plan of rearranging stock ownership among the family members has actually diminished the rate of growth in the family’s wealth. They recognize that their foray into stock-picking has been a failure, and conclude that they need professional assistance, the better to pick the right stocks for themselves. So they hire stock- picking experts—more Helpers!—to gain an advantage. These money managers charge a fee for their services. So when the family appraises its wealth a year later, it finds that its share of the pie has diminished even further.

in mind that the industry costs reflect fund expense ratios only; they ignore sales charges, paid on the purchase of shares in almost one-half of all mutual funds. Since we offer only no-load funds, Vanguard’s cost advantage is in fact substantially larger than it appears.) The impact of cost is greatest where the time horizon is longest. If a low-cost complex operates at a cost of ¼ of 1% (assuming a market return of 10%) over 25 years, it captures 95% of the market’s return. A high-cost complex (at 2%), would capture but 63%. So here is another form of the tyranny of compounding—cost compounds, too! Since 1980, the expense ratio of the average Vanguard fund has dropped from 59 to 28 basis points, even as the industry’s expense ratio has risen from 99 basis points to 125 (Chart 5). Thus our margin of advantage has risen from 40 basis points to almost 100—by two and one-half times—an 80% competitive advantage in unit costs. This advantage is pervasive—in our U.S. and international stock funds alike; in our balanced funds; in our tax-exempt and taxable bond funds; and in our money market funds. After all, given Vanguard’s unique mutual structure, we have two ways of earning profits for our shareholders: Investing in portfolios of securities that provide generous long-term returns; and minimizing the drag of intermediation costs so as to provide the highest possible portion of those returns.

Why was mutuality so important? Consider this reality: Mutual funds are simply diversified investment portfolios that invest in securities traded on America’s vibrant financial markets. Both common sense and the historical record tell us that equity mutual funds as a group earn gross returns on their portfolios that equal the returns generated in the stock market, but only before fund costs are deducted. The net returns funds deliver to their investors fall short of those gross returns by the amount of their costs—all of those management fees, operating expenses, portfolio transaction costs, and sales commissions that funds incur. Just as gambling becomes a loser’s game after the croupier’s rake descends, so beating the market becomes a loser’s game after the costs of the financial intermediaries are deducted. Fund costs are heavy, indeed onerous. The average common stock mutual fund incurs all-in costs of 2.8 percent per year. Think about it. If the annual returns of the stock market average 10 percent, fund costs would erase fully 28 percent of it. What is more, the impact of costs grows dramatically over time. Compounded over a quarter-century, fund costs at that level would consume, not 28 percent, but fully 47 percent(!) of the final value of the investment. In investing, costs matter. Over a long-term time horizon, costs may represent the difference between a comfortable retirement and a spartan one.

In the money market fund segment, of course, current yields have no necessary relationship to past or future yields—don’t forget that it is impossible to have both a fixed income payment and a fixed principal value—the capital flows (at least ever since this segment reached maturity in the mid-1980s) seem to represent a residual figure, with money coming into the funds because it is coming out of stock and bond funds, and vice versa. The Tragic Flaw But the tragic flaw of this industry is that mutual funds have failed to give our investors an adequate share of the returns actually generated in the stock market, the bond market, and the money market. During the two decades ending December 31, 1999, these returns were at the highest levels in U.S. history: 18% per year for stocks, 10% for bonds, 7% for the money markets. As a result, despite relative returns that significantly lagged those of the markets in which they invested, fund investors enjoyed good absolute returns. In buoyant markets, that lag may—MAY!— have been a tolerable flaw. After all, in that 18% stock market, the average equity fund did provide a 15% return. But when the financial markets generate significantly lower returns, such a lag will become intolerable. And, in my judgment, it’s precisely such an era that we have entered. The mathematics of the stock market— today’s low dividend yield plus nominal earnings growth—suggests an investment return averaging about 6½% over the coming decade.

being a sound long-term investment to a product offering a short-term marketing opportunity; from providing stewardship for a lifetime to the participating in the momentum of the marketplace. Myth #2. Mutual Fund Managers are Long-Term Investors Equally depressing, at least to me, is the baneful change in focus of mutual fund managers. I mince no words: Fund managers, once long-term investors, have become short-term speculators. From the time I wrote my Princeton thesis until the mid-1960s, average fund portfolio turnover normally ran in the 15%-20% range, a putative holding period of five to seven years for the average stock fund. In recent years, turnover has consistently run over 80%, and was 90% last year. Alas, in this era of day traders—one-day traders—fund managers can be accurately described as “406-day traders.” If “speculator” is too strong a word for the typical fund manager, it’s surely infinitely closer to the mark than “long-term investor.” Their high turnover rate, interestingly, is remarkably pervasive. It ranges from an average of 146% for mid-cap growth funds to 62% for small-cap value funds. And even the median large-cap fund turns its portfolio over at 63% (excluding stock index funds, which turn over at only about 9%). High turnover is not a statistical aberration; it is almost as prevalent as the air we breathe. Again, this industry’s shift to a marketing ethos bears an important share of the responsibility for soaring portfolio turnover.

Binny described the sale itself as a discipline of sustained optionality: the company had raised billions, scaled to leadership, and at the right moment allowed a strategic acquirer to write the final cheque. The decision was less an admission of capitulation to Amazon's war chest than a calibrated exit at the top of a valuation cycle.

0.90% per year? A 27% cost increase. (Including Vanguard, whose equity fund costs—using the ICI methodology—are down from 0.67% to 0.27% since 1980, a reduction of 60%!) If there is price competition, how can the industry possibly explain how the industry’s sole very low cost provider has, since last July, accounted for an eye-popping 80% of the cash flow into direct- marketed (no-load) stock and bond funds . . . without significant competitive response. (That’s right: Vanguard cash flow, $40 billion; other direct marketers $9 billion.) In what other industry could a relative upstart capture a market share of 80% and not have a single competitor imitate its strategy? How one can equate this picture with the allegation that mutual funds compete vigorously based on price is beyond my comprehension. Consider this simple example. Assume there are just two large mutual funds, Fund A charging 2% per year and Fund B charging 0.20%. In the first year, investors are unaware of the role costs play, and Fund A has sales of $100 million and Fund B zero. In the next year, investors wake up. Fund A has no sales and Fund B $100 million. Miraculously, under the ICI methodology, the cost of fund acquisition (not ownership) has dropped by 90%—from 2% to 0.20%. How would Fund A’s manager respond? If the manager cut the fee to 1%, his profits would be squeezed, yet a cost-conscious marketplace would ignore it. At 0.

Reliance on the fundamentals of investing means investing in corporate businesses for the long run. Reliance on speculation, and gambling on changes in the price-earnings ratio, means investing in stock certificates-pieces ofpaper-for the short run. Sadly, most mutual funds preach the long run, but practice the short run, turning over their portfolios at a costly and grotesquely tax-inefficient rate of some 90% per year. I urge you to ignore the practices mutual funds follow ... and attend to the practices they preach. For the long term investor who wants to stay the course, reliance on a sensible balance of stocks and bonds is essential-more important today, I believe, than for as far back in market history as most of you here can remember. (I'm older!) Such a course will mitigate emotion in investing and emphasize reason and common sense. Simplicity, then, above all: Balance. Markets Fluctuate. Invest for the Long-Term. Stay the Course. Simplicity also gives us a surprising rule for measuring investment success. The central task of investing is to realize the highest possible portion of the return earned in the financial asset class in which you invest-realizing, and accepting, that that portion will be less than 100%. Why? Because of cost. To state the obvious, we know intuitively that our cash reserves will inevitably earn less than the going short-term market rate.

So we had to seek yet another diamond. And we quickly found what was to prove to be the rival of the fabled Kohinoor diamond in size. The fact that investment management was outside of Vanguard’s mandate led me, within months, to what may seem obvious, a great idea that I’d toyed with for years. And before 1975 had ended, we started the world’s first index mutual fund. Our first index portfolio—based on the Standard & Poor’s 500 Stock Index—was derided for years, and first copied only after a full decade had passed. But very soon this fund, once called “Bogle’s Folly,” will be the largest mutual fund in the world, one of 28 index mutual funds that today constitute nearly one-third of our business. The trick of the index fund, I argued to the Board, was that it didn’t need to be “managed;” it would simply buy all of the stocks in the Index. The argument narrowly carried the day, and with this quasi-management step, we had edged into the second side—the investment side—of the triangle. How to get the final and third side—the marketing function? Why, just find another diamond. Our idea was to eliminate the very need for distribution, doing away with the Wellington network of brokers and relying, not on sellers to sell fund shares, but on buyers to buy them. So, in 1977, after yet another divisive battle, we made an unprecedented conversion to a no-load, sales charge-free marketing system. Once again, we’ve never looked back. We’ve never had to.

It is hardly farfetched, then, to expect future bond returns that are likely to parallel those of stocks. If so, the traditional 3% equity risk premium—the amount by which stock returns have exceeded bond returns over the past century—may be far smaller, perhaps even non-existent. There are, of course, those who say that there is some God-given mandate that an equity premium must exist. Yet history tells us that bond returns have exceeded stock returns in one out of every five decades. The reality is that restoring an equity premium to stocks will require either (a) lower interest rates, or (b) some combination of higher earnings growth, higher dividend yields, and lower P/E ratios, which is likely only if there is another downward leg in the stock market. In any event, my view is that we are entering an era of lower returns on financial assets. After a golden era of truly extraordinary returns, investors have to realize that reality is now the rule of the day. But the faith of investors in our financial markets will be restored far more quickly if we do three things: First, encourage our clients to develop realistic expectations about future market returns. Second, help them to invest carefully, to increase their savings, and to observe the time- honored principles of diversification and asset allocation.

This thrilling ride drew on my every talent—however modest—and seemed to ignore my numerous weaknesses. My energy and sheer delight in making a radical departure from industry norms and in building a new business, and my feisty taste for the competitive battle were unflagging. But while my spirit was willing, my flesh was weak and growing weaker by the day. A genetic heart disease, first manifested when I was 30 years of age, gradually worsened, and by early 1995, the right half of my heart had ceased to beat. I decided to step down, and end my career as Vanguard’s chief executive. February 1996, Break #3—“You Have A New Heart” Of course my failing heart was a major reason for my decision. But I also did not intend to outstay my usefulness, and, truth told, I had found the operating challenge of managing a firm that had already grown to some 5000 crewmembers (on the way to 10,000) paled by comparison with the entrepreneurial challenge of building a new company and establishing its character—its common sense investment philosophy and its ethical human values. Further, I’d remain at Vanguard, for the Board agreed that I would continue to serve as Chairman. In October 1995, I entered Hahnemann Hospital to await a heart transplant. As a round- the-clock intravenous line carried heart-stimulating drugs that kept me alive, I remained cheerful, optimistic, and of course busy in my Vanguard duties. On February 21, 1996, after 128 days in the hospital, I received my new heart.

Man never is, but always to be blest.” Just as the dream of the perfect plan lies little chance of coming true, so the anticipation of being blessed, Pope tells us, inevitably falls short of realization. It occurs to me that the main fact or that causes investors to ignore the good plan of indexing is not just that it is boring—the market return is only, well, the market return—but that the index strategy seems dumb. In a sense, of course, it is. Perhaps it is also deaf and blind. But as it turns out, the dumb strategy leads to a smart, even brilliant, decision. Hear Warren Buffett on this subject: “By periodically investing in an index fund . . . the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when “dumb” money acknowledges its limitations, it ceases to be dumb.” But if the index fund strategy is a good plan—maybe even the best plan available to most of us mere mortals—it need not be the end. While the odds against picking a superior mutual fund have been powerful, they have not been insurmountable. In a given decade, perhaps one fund in five has beaten the market (before taxes). And there are some simple common sense principles that should help you to select funds that can earn a generous portion of the market’s return, although they too are all too likely to fall short of 100%.

international stocks. The net result of all four examples, to tip my hand, is that, among each of these key market sectors, RTM is alive and well. Let’s begin with growth stocks (generally, those with above-average earnings growth, price- earnings ratios, and market-to-book ratios) and value stocks (lower in each case, and offering above- average yields). For this study, I’ve done a 60-year examination of growth mutual funds—those with stated growth objectives and demonstrated above-average volatility—and value mutual funds—equity funds stating that they seek both growth and income and demonstrating average volatility. (Before published industry norms became available in 1968, I’ve relied upon a sample of funds whose portfolios and annual returns made this distinction clear.) The conventional wisdom today is to give the value philosophy the accolades as superior to the growth philosophy. Perhaps this is so because so few have examined the full historical record. Nonetheless, over the long run, as shown in Exhibit IV, RTM proves powerful and profound. In the early years, growth funds controlled the game, and were clearly the winners from 1937 through 1968. At the end of that era, the investment in value stocks was worth just 62% of the investment in growth stocks. Then, value stocks enjoyed a huge resurgence through 1976, redressing almost precisely the entire earlier deficit.

Or should they? Think about it for a moment. Why should the board bear the ultimate responsibility when it doesn’t even have the ultimate responsibility? It is the stockholders themselves—surely this audience, above all, knows that!—who bear the ultimate responsibility for corporate governance. And as investing has become institutionalized, stockholders have gained the real—as compared with the theoretical—power to exercise their will. Once owned largely by a diffuse and inchoate group of individual investors, each one with relatively modest holdings, today the ownership of stocks is concentrated—for better or worse!—among a remarkably small group of institutions whose potential power is truly awesome. The 100 largest managers of pension funds and mutual funds alone now represent the ownership of one-half of all U.S. equities: Absolute control over corporate America. Together, these 100 large institutional investors constitute the great 800-pound gorilla who can sit wherever he wants to sit at the board table. But the gorilla doesn’t even come to the meetings. With all that power has come little interest in corporate governance. There is an amazing disconnection between the potential and the reality—awesome power, but rarely exercised. Yet institutional managers could hardly have been ignorant of what was going on in corporate America.

managers sowing the seeds of their own performance inferiority today? Stranger things have happened. Well, these trends suggest why I describe the present era as the Age of Investment Relativism, in which the overarching goal is to avoid inferior short-term returns relative to the S&P 500, rather than to achieve superior absolute long-term returns. Since quantitative science entered the business of mutual fund performance in the mid-1980s, relativism has become the basis of a comprehensive performance measurement system. Beta (risk, measured by the fund’s price volatility relative to the 500 Index), and Alpha (the fund’s rate of relative return adjusted for risk) have entered our lexicon. We also have the Sharpe Ratio, measuring a fund’s excess return over the Treasury bill relative to its risk (standard deviation), not to be confused with the information ratio (Selection Sharpe Ratio), which measures excess return over a benchmark standard—usually, of course, our devilish friend, the S&P 500. I do not believe that this focus on simplistic mathematical precision is an entirely healthy state of being for managers or for their clients, nor for the market itself. Yet there is, as yet, no end in sight—no Omega on the horizon. The Real Villain: The Index Fund Surely the most important reason by far for the defensive reaction of managers to index comparisons is the index fund itself. The index is a mean adversary, but the index fund is the real villain of the piece.

Perhaps $60 billion of this $150 billion will be received by investors in tax-deferred retirement programs and $90 billion by taxable investors, carrying an estimated tax liability of more than $22 billion. I can only hope that on next April 15 they will be ready to pay it.

It is said that when we have strong managers, weak directors, and passive owners, it's only a matter of time until the looting begins, and it will happened right under the eyes of the traditional gatekeepers of our capitalistic system, the corporate directors whose prime responsibility is to represent the interests of the shareholders who elected them.faithful

languished at 1000 in 1982—sixteen years later. (In the next sixteen years a rather different market environment would take it to 8000!) Our firm experienced 80 consecutive months of capital outflow (more shares redeemed by investors than purchased, every single month). But bad times helped us in critical ways. With business so poor, the directors were open to suggestions for improvement. I had long believed that having the lowest expense ratios would not be good enough to establish us as the legitimate, low-cost provider of mutual fund services. We would have to also eliminate all sales charges. So I urged the board to abandon the old broker-based channel to a new direct channel, the better to serve a public which, I posited, would be increasingly savvy about investing, well-educated, and self-motivated. Wellington Management Company resisted, and we were able to wrest control of marketing and distribution from them, cut expenses again, and make an unprecedented conversion to no-load distribution in early 1977. (Another close call, 8 to 5, at a still-divided board.) Now we were both administrator and distributor. So we turned our attention to the third leg— investment management—of the three-legged stool on which mutual fund activities rest. The boom in money market funds, which were to grow to more than 50% of industry assets in 1985, gave us our entree.

of the three higher-cost quartiles averaged about .76; the lower-cost quartile averaged .95.) This relationship drives home the “costs matter” thesis, with powerful force. Our conclusion, then, adds a key caveat to the BHB phrase, modifying it as follows: “Although investment strategy can result in significant returns, these are dwarfed by the return contribution from investment policy, and the total return is severely impacted by costs.” This conclusion is derived, not only from the limited evidence provided by our study of balanced mutual funds, but in an exhaustive study of the returns of all 741 domestic equity mutual funds in operation over the past five years. The analysis separated the equity funds into nine “style box” objective categories—large, medium, and small capitalization stocks on one axis, growth, value, and a blend of the two on the other. In each style box, without exception, funds in the low-cost quartile consistently outpaced funds in the high-cost quartile. What is more, each 10 basis points of expense ratio advantage was accompanied by a 21-basis-point advantage in net return. That is to say, a 10% return on a high-cost fund would translate, not merely into an 11.1% return for a fund with a 1.1% expense ratio advantage (high-cost balanced funds 1.6%, low-cost funds 0.5%), but a 2.3% total return advantage. That is a 23% enhancement of annual return.

In “legal rights and machinery, the stockholders as a class are king . . . they can hire and fire managements and bend them completely to their will.” He was—and he is—right. But he was—and he is—right when he added that “the assertion of rights by stockholders in practice is almost a complete washout. Unless prodded violently into action, they show neither intelligence nor alertness. They vote in sheep-like fashion for whatever management recommends, no matter how poor the record of accomplishment may be . . . This attitude of the financial world toward good and bad management is utterly childish . . . The leading investment funds could contribute mightily to the improvement of corporate managements . . . but have shied away . . . missing a great opportunity for rendering service to the investing public.” And so it remains today. But it wasn’t always so. Way back in 1949, Fortune suggested that, “the mutual fund is the ideal champion of . . . the small stockholder in conversations with corporate management, needling corporations on dividend policies, blocking mergers, and pitching in on proxy fights.with

interest rates (i.e., not at all). In the 1970s and 1980s, a weak dollar increased strong foreign returns by 20%. So far, in the 1990s, a strong dollar has reduced weak foreign returns by a further 30%. In the long run, my best guess is that the dollar will be a neutral factor. The returns will depend on how foreign corporations perform, and whatever else may be said, I’m dubious that those in France, England, Germany and Japan will outpace those in the U.S. (I may be exhibiting a bit of Jingoism here.) The emerging markets? Perhaps, but risks there clearly abound and are notoriously unpredictable. Skeptical as I am, however, I will concede there is a place for international investing from a diversification standpoint. Indeed, I have no hesitancy recommending an international position-- say, from 5% of equities to no more than 20%, given the extra economic and financial risks and the ever-elusive ability to forecast the strength of the dollar. In all, we have been favored with the fruition of the ancient Chinese curse: “May you live in interesting times.” But especially interesting they are, with stocks soaring to unprecedented heights as new forces of technology and globalization permeate our world. We can’t walk away from this moment, so let’s deal with it. To this end, let me close with five simple principles of investing which may help you: First, invest you must.

inadequacy of pension plan assets to meet their payout liabilities to retirees is well on the way to becoming our next financial scandal.  Three, the failure of our traditional gatekeepers. In the recent era, auditors, through their provision of highly profitable consulting activities, became partners, if not co- conspirators, with managements, and relaxed traditional professional standards. Regulators and legislators (who in 1993 forced the SEC to back down on requiring that option costs to be treated as—of all things!—corporate expenses) also ignored the public interest. And corporate directors failed to provide, as I put it in my book, the necessary “adult supervision of these geniuses” who managed the firms. Put more harshly, in an unattributed quotation that I came across a few years ago, “When we have strong managers, weak directors, and passive owners, don’t be surprised when the looting begins.” And that’s, of course, what we’ve seen at Enron, WorldCom, and too many others. In Investment America:  One, the vanishing ownership society. Almost unobserved, direct holdings of stocks by individual investors have plummeted from 92 percent of all stocks in 1950 to only 32 percent today, as corporate control fell into the hands of giant financial institutions— largely pension funds and mutual funds—whose share soared commensurately, from 8 percent to 68 percent, a virtual revolution in ownership.

Make the approach to managing Embedded Alpha credible, then aggressively promote it . . . This approach can improve the probability of superior returns. (I’m not quite sure how aggressive promotion can relate to superior returns.) Perhaps surprisingly, the study presents no data whatsoever on the dimension of Embedded Alpha. “Purposely,” we’re told, “the paper does not focus on data and statistics.” But, the dimensions of cost are astonishingly large. Since I’m not an expert on the economics of the investment counsel business, let me now turn to the mutual fund business to give you some idea of just how large they loom.picture:

a star system not unlike Hollywood’s has emerged, with the brightest stars attracting the largest cash flows from investors. Doubtless some managers have used this New Era of infinite information to their advantage. After all, the new Compaq 700 has 5000 times(!) the power of a 1985 IBM PC. But it is in the nature of markets that for each winner there must be a loser. Beating the market is a zero-sum game. The average fund manager can’t win. When asked if the average manager could win, Columbia University’s legendary Benjamin Graham, mentor to the even more legendary Warren Buffett, said: “No. That would mean that the stock market experts as a whole could beat themselves—a logical contradiction.” Which quickly leads to the second truth: While all investors as a group share the market’s gross return, their net return is reduced, dollar for dollar, by the costs of financial intermediaries. After costs, beating the market is a loser’s game. Yet in the New Era, the relative returns earned by mutual fund investors have not merely stayed the same; they have gotten worse. Why? Because the costs paid by mutual fund investors have risen. Result: the share of market return earned by fund investors has declined even further. How much have costs risen? In the Old Industry, the average equity fund carried an expense ratio of about 0.75% of assets per year; in the New Industry, the average is more than 1.6%—an increase of more than 100%.

the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die.” Meet Some Great Need . . . Perform Some Great Deed These three economists—the greatest in modern history—are all sending us the same message. Let’s follow their advice. Let’s put animal spirits first, and gigabillions second; the joy of creating and the will to conquer first, and the mindless conformity of greed last; and the greater interest of others, the love of what is honorable and noble and the grandeur and dignity of our own characters first, and only then consider our own self-interest. Strive to meet some great need or perform some great deed, not for yourself, but for others. Enter into business with idealism and enthusiasm and energy. Enter into the battle for ideas, a battle for which you’ve been so well prepared in your studies here, with determination and joy. Business has been my calling for a half-century. It’s been, well, wonderful and each one of you can be as blessed in your lives and careers as I have been in mine, for today the opportunities are infinite. Go out and make business your calling. Help us to build a better world. Just do it!

times the income of a person making $50,000, statistics tell us that his net income, after taxes and even after the much higher living expenses experienced at that income level, is sixty times as high. So I hope we all will consider our giving, not just in dollar terms, but in proportion to good fortune when it comes our way. Where to Give Once you’ve decided how much to give, you then have to consider where to give it. Again, far be it from me to answer that question for you. But I will take this opportunity to tell you why I believe that your community United Way should be an important focus of your beneficence. Again, I explained my reasoning at my de Toqueville award ceremony five years ago. For I mentioned two principles. One, which you’ve heard, is that giving with an open hand is a moral obligation for those who have received. But this second principle also helps shape my own giving philosophy: “Always remember your community. It is here in our community where we live our lives, where our homes serenely repose, where our fortunes—for they are indeed that—have flourished. When we come to honor our obligation to give and to capitalize on our opportunity to give, what better object can we have than our own community, with its ever-infinite potential for betterment? “St. Luke also told us . . . ‘and to whom men have committed much, of him they will ask the more.

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.

Read today, my thesis would probably impress you as no more than workmanlike, perhaps a bit callow, but above all, shamelessly idealistic. On page after page, my youthful idealism speaks out, calling again and again for the primacy of the interests of the owner of mutual fund shares. “The prime responsibility (of fund managers) must always be to their shareholders.” And the deal must be fair: “there is some indication that costs are too high,” and that “future industry growth can be maximized by concentration on a reduction of sales charges and management fees.” After analyzing fund performance, I concluded that “funds can make no claim to superiority over the market averages,” perhaps an early harbinger of my decision to create, nearly a quarter-century later, the world’s first index mutual fund. And in my conclusion, I powerfully reaffirmed the ideals that I hold to this day: The role of the mutual fund is to serve—“to serve the needs of both individual and institutional investors . . . to serve them in the most efficient, honest, and economical way possible . . . The principal function of investment companies is the management of their investment portfolios. Everything else is incidental.

investment is $108,000, at the end of 25 years, nearly a tenfold increase in value. Give yourself the benefit of all the time you can possibly afford. Of course, time has marched on since I wrote those words. Even taking into account the sharp market decline during the dismal past year, the decade-long 14.4% return on the S&P 500 index fund has already carried the value of an initial $10,000 investment in the index fund to $38,400. While the 25-year period that I noted in the book is not yet half over, Pillar of Wisdom #3 is looking pretty good. Even a modest return of 7.2% on stocks during the next 15 years— one-half the rate of the past decade—would result in the realization of that 10% target and the accumulation of the resultant $108,000 of capital over 25 years. Surely this example of the march of time bears out the words of the poet Maya Angelou: “Since time is the one immaterial object which we cannot influence, neither speed up nor slow down, add to nor diminish, it is an imponderably valuable gift.” And so it is that time provides among the most valuable of all gifts in investing. Do your best to ignore the short-term events that, day after day, seem to overwhelm our thinking, and follow the very first principle for managing your money: Give yourself all the time that you possibly can. Pillar 4. Nothing Ventured, Nothing Gained. It pays to take reasonable interim risks in the search for higher long-term rates of return.

precious few portfolio managers have measured up to over time. (3) The development of a new paradigm for bond fund management, using innovative three-tier structure of short-term, long-term, and intermediate- term portfolios that quickly became the industry standard. And (4) the abandonment, literally overnight, of a proven broker-dealer, commission-oriented “supply-push” distribution system in favor of a new and untried no-sales-charge, “demand-pull” system for self-motivated investors. None of these changes came easily. To accomplish them required a devil-may-care attitude; a blasé disregard for risk; a profound conviction, without hard evidence, that they would work; and the sheer energy required to get it all done. Yet despite what we regarded as our noble intentions, the completion of our structure was initially opposed by the Securities and Exchange Commission, which rejected our structure and dawdled over our appeal for years. When the Commission finally gave us its unanimous approval, it came with an endorsement that proved to be prophetic: “The Vanguard plan actually furthers the (1940 Investment Company) Act’s objectives, and promotes a healthy and viable complex in which each fund can better prosper.” And prosper we did. By the time the SEC finally gave us the green light in 1981, seven long years after we began, the stock market recovery had begun, and our assets had doubled, from $1.4 billion to $3 billion.

What were those market metrics that so concerned me? Stocks, as measured by the broad-based Standard & Poor’s 500 Stock Index, were selling at 32 times earnings, up from 24 times in 1997 and twice the historic norm of 16 times. The $17 trillion value of the U.S. stock market was nearly 200% of our nation’s $9.4 trillion GDP, up from 107% in 1997 and more than double the 80% relationship that had marked earlier highs. And, drawing on Jeremy Siegel’s Wall Street Journal essay (“Big-Cap Tech Stocks are a Sucker Bet”), nine of the most popular stocks of the day (Cisco, Oracle, Nortel, Yahoo!, etc.), had risen in value from $190 billion in 1997 to $1.6 trillion. At their median price of 153 times earnings, even if the estimates of 30% annual earnings growth projected for them were actually achieved, they would still be selling at 95 times earnings in 2004, and 46 times in 2009. What a pipe dream! The Bubble Bursts We all know that trees don’t grow to the sky. They couldn’t . . . and they didn’t. And many investment veterans had a pretty good idea of what was going to happen in the wildly- inflated stock market. While none of us, I think, had any idea of when, the burst in the bubble began at the very moment I was preparing my remarks. When reward reached its pinnacle, risk was at hand. The ratio of the NASDAQ’s capitalization to that of the NYSE has tumbled from 60% at the high, to just 21% currently.

Estimated Costs of Securities Intermediation, 2007 (billions) Investment Banking and Brokerage $308 Mutual Fund Operating Expenses 100 Hedge Funds 45 Variable Annuities 30 Pension Fund Advisory Fees 15 Legal / Accounting Fees 15 Financial Advisors 10 Bank Trust Departments 5 Total $528 billion 1. disservice to investors. Perhaps I shouldn’t speak so bluntly, but I’m inspired by this sentence from last week’s The New York Review of Books, part of its review (a little late!) of my previous book, The Battle for the Soul of Capitalism: “After a heart transplant eleven years ago, Bogle retired to a life of full-time hell-raising.” Well, no. No. Paraphrasing Harry Truman: “I’m not giving ‘em hell. I’m just telling ‘em the truth, and they think its hell.” The soaring costs of mutual funds is just one part—actually a relatively small part—of the costs that investors incur in our nation’s system of financial intermediation. The direct costs of the mutual fund system (largely management fees and operating and marketing expenses) are currently running at an annual rate of almost $100 billion, but funds are also generating some $10 billion of fees to financial advisers, and enormous transaction fees to our brokerage firms and investment bankers, and lawyers, and all those other facilitators.

Johnson, which we talk about later, has still the highest score despite falling from 65 at the end of 2018 to 58 at the end of 2019. To some extent, reputational risk comes with the territory of medical equipment and pharmaceuticals, especially in the litigious US market but the only way of avoiding it altogether would be to hold no investment in this area, which strikes us as a counsel of despair given the major benefits which the sector can produce. In 2019, we also sold our position in 3M, which has faced numerous negligence lawsuits in recent years over whether it supressed information about the health risks associated with the chemicals (PFAS) used in its firefighting foam for military bases and manufacturing facilities. Reportedly, PFAs have contaminated drinking and groundwater for over 1.9m Americans, posing risks of cancers and immune system failure in children. At the end of 2019, the four companies with the lowest RepRisk indicator scores, which all have a score of zero, were: 1. ADP 0 2. IDEXX 0 3. Intuit 0 4. Sage 0 This looks similar to the list at the end of 2018, with ADP and Intuit replacing Intertek and Waters. Intertek and Waters’ RepRisk Indicator increased to 16 and 18 respectively.

in the number of dollars that investors are willing to pay for each dollar of corporate earnings; that is, the annualized percentage change in the P/E multiple. Simply add the two categories of return together and, viola! we have the total returns generated in the stock market. (It works!) Over the very long run, it is the economics of investing—enterprise—that has determined the total return on stocks. The momentary emotions that surround investing—speculation—so important over the short run, have ultimately proven to be virtually meaningless. For example, the 10.0 percent average annual return on U.S. stocks during the past century was almost identical to the 9.9 percentage points of investment return, an average dividend yield of 4.6 percent, plus average annual earnings growth of 5.3 percent. Speculative return added only one-tenth of one percent to that total. Despite the transient booms and busts of stock market history, for the investors who have stayed the course, buying and holding a portfolio invested across all of American business, has been an extraordinarily successful strategy. The Triumph of Speculation Keynes had predicted that otherwise sensible professional investors would gradually abandon their focus on enterprise and follow the ignorant crowd of uninformed individuals in betting on the psychology of the market, attaching their hopes to a favorable change in the conventional basis of valuation, i.e., that they are speculators.

To make matters still worse, the new managers feel compelled to earn their expensive keep by trading the family’s stocks at feverish levels of activity, not only increasing the brokerage commissions paid to the first set of Helpers, but running up the tax bill as well. Now, of course, the family’s earlier 100 percent share of the dividend and earnings pie is further diminished. “Well, we failed to pick good stocks for ourselves, and when that didn’t work, we also failed to pick managers who could do so,” the smart cousins say. “What shall we do?” Undeterred by their two previous failures, they decide to hire still more Helpers. They retain the best investment consultants and financial planners they can find to advise them on how to select the right managers, who will then surely pick the right stocks. The consultants, of course, tell them they can do exactly that. “Just pay us a fee for our services,” the new Helpers assure the cousins, “and all will be well.” Alas, the family’s share of the pie tumbles once again. _ Alarmed at last, the family sits down together and takes stock of the events that have transpired since some of them began to try to outsmart the others. “How is it,” they ask, “that our original 100 percent share of the pie—made up each year of all those dividends and earnings— has dwindled to just 60 percent?

The Commitment of Citizenship In my day, I’ve met many successful men and women, too many of whom express their pride in having done it all themselves. But I don’t believe that anyone can take sole credit for their success. Most of us have been blessed by the nurture and love of our families, the support of our friends and colleagues, the dedication of our teachers, and the inspiration and guidance of our mentors. “We did it ourselves.” Really? When I hear that, I’m bold enough to ask, “Now just how did you arrange to be born in the United States of America?” And so I come to my final affirmation of Goethe’s wisdom about commitment: Commitment to our Nation—America the Beautiful, in the words of the hymn we’ve just sung. Please neither derogate it nor take it for granted. We are one lucky bunch. Just by being right where we are today. We’d best not forget the elementary truth that the moment we commit ourselves to doing all we can, every day, to live up to the values of our Founding Fathers and the principles of our Constitution, then providence moves too, fostering the general welfare of this great land, justice and domestic tranquility, the equality in which we are all created, and our inalienable rights to life, liberty, and the pursuit of happiness—words that are so familiar to us all. When you boldly commit yourselves to good citizenship, magic will follow for America.

management fee for every new fund and every fee increase for an existing fund? There is simply no way that fund directors—independent and affiliated alike—can avoid accepting responsibility for the harmful trends that beset the industry. Why do the watchdogs remain silent? One reason may well be that the independent directors of large mutual funds are so well paid that the line has blurred between a “disinterested” role (the word the Investment Company Act of 1940 uses to describe independent directors) and an “interested” role (the word used to describe directors who are paid employees of the fund’s investment manager). A 1996 study showed that the annual fee for an independent director of the ten highest-paying fund complexes averaged $150,000, nearly double the $77,000 directors’ fee paid by the ten highest-paying Fortune 500 companies. Fund director’s fees are even higher today. In a curious and disturbing paradox, it is hardly unusual for independent fund directors to be paid far higher fees than those paid to the independent directors of the very corporations that manage the funds. The highest-paid fund directors, in five mutual fund groups, in fact, receive fees averaging $386,000 annually (in two cases, supplemented by $100,000-plus annual pensions), compared to just $47,000 for their management company counterparts, directors of the companies (often large financial conglomerates) whose business is the operation of the funds. (Chart 6.)

The point is this: Over the very long run, it is the economics of investing—enterprise— that has been virtually entirely responsible for the total return on stocks. The evanescent emotions of investing—speculation—so important over the short run, have ultimately proven to be virtually meaningless. In the past century, for example, the 9.5 percent average nominal annual return on U.S. stocks (second column from right) has been composed of 9.3 percentage points of investment return (an average dividend yield of 4.5 percent plus average annual earnings growth of 4.8 percent), and only 0.2 percent of speculative return. But don’t expect history to repeat itself. When we look to the future, we should largely ignore historical returns.investment

daily busyness. But if business has been the engine, and businessmen the beneficiaries of America’s incredible worldly success, surely business and businessmen have the duty to use some of their resources and their extraordinary ability for innovation, organization, and reaching new frontiers to help to build a better world. Such a commitment requires little more than an enlightened sense of self-interest, a combination of Adam Smith’s economic philosophy that fosters the wealth of nations with his moral philosophy based on honor, dignity, and nobility. American business must make America its business. What profiteth a business if it gain the whole world yet lose its own soul? The Role of Education If there is a single force that can build a better America and, correlatively, a better world, we all know what it is: Education. Education is the foundation of knowledge and discovery, of morality and motivation. Yet American education is far behind where it ought to be. Relative to other developed nations, our ranking in mathematics and science and language is no better than mediocre. Worse, we have an underclass of young American citizens who, at tender age, are almost estopped from ever fulfilling a productive role in society. Nearly 40% of fourth graders cannot pass basic tests of reading ability. One of nine high school students fails to graduate. One-third of our teenagers never enter college.

Let me now turn from the miracles of what Vanguard’s IT group has accomplished to the miracles that technology has brought to the mutual fund industry. These four stand out:  The emergence of a financial system that has enabled the professional money managers of funds to offer a whole new variety of investment products, to provide remarkable liquidity for transactions, and to transact business around the globe at the speed of light.  The provision of an up-to-date information network that provides data about mutual fund portfolios and performance so vast as to be beyond the ability of the human mind to absorb.  The development of websites that not only provide fund shareholders with real-time account valuations, but also financial planning advice, including recommendations on saving for retirement and on the allocation of investment assets.  The availability of a communications network so efficient that investors can purchase and redeem fund shares instantaneously (albeit so far with the transactions executed no more frequently than hourly), without ever moving from their desktop computers. But, with all of this extraordinary technology available to investors, I ask you tonight: To what avail? Yes, computer technology has played a major role in the growth of the mutual fund industry, adding a whole new order of magnitude to the growth fostered by the 18-year bull market in stocks.

Deveshwar was among the first global tobacco chiefs to sense the impending decline of the cigarette business, Open notes. As ITC's helmsman he looked beyond shareholder value to overall gain for environment, society and nation. The paper business expansion was originally framed as securing raw material for pulp; Deveshwar saw the potential for rural employment and environmental benefit, and instructed the team to scale plantation targets 10x —.

Emotions seem more likely to reduce that investment return than to increase it. With a price-earnings ratio of about 22 times based on normalized earnings (far higher relative to actual earnings during the present recession), some retreat toward the long-term norm of 16 times seems more than likely, producing a negative speculative return of 1% to 3%. The result, if all goes well: A stock market return in the range of 6% to 9% per year over the next decade. That may not sound like much. But don’t forget that the long-term norm is 9%, and that in one decade out of every three stocks have produced less than 6% annually. And before you write-off stocks, don’t forget that prospective bond returns are also low. The U.S. Treasury 10- year bond, for example, yields just 4¼% today, and money market fund yields will soon be below 2%. Wise investors will scale down their expectations to reflect these new realities. My advice to long-term investors: Stick to prudent investment principles; hold a stock/bond allocation consistent with your own risk tolerance; and make sure your portfolio is broadly diversified. Let economics rule your decisions, keep your emotions out of play. And then follow the wisest of all investment rules: Stay the course. Market Returns in the Coming Decade? (2001 - 2011) 20x 22x Dividend Yield 1.5% 1.5% Earnings Growth 7.0 7.0 Investment Return 8.5% 8.5% Speculative Return* -1.0 Market Return 7.5% 8.5% 30x 1.5% 7.0 8.5% +3.1 11.

When investors, in the hope of carving out an edge, use index funds to make outsized bets on narrow market sectors or to vigorously trade their portfolios, they have adopted the ultimate losers’ strategy. When investors abandon the wisdom of investment and undertake the folly of speculation, using a great idea to implement a flawed strategy, they are bound to be disappointed. There is an old prayer that reads: God grant me the serenity To accept the things I cannot change, The courage to change the things I can, And the wisdom to know the difference. I hope it is wisdom rather than stubbornness that persuades me that I can help to change what is going on today in indexing and return us to our roots. First, I’ll present a perspective on the remarkable success investors have achieved when indexing has been properly used for investment purposes, and then I’ll discuss why investors will achieve self-defeating results when index strategies are abused for speculative purposes.

The magic of compounding accelerates sharply with even modest increases in annual rate of return. While an investment of $10,000 earning an annual return of +10% grows to a value of $108,000 over 25 years, at +12% the final value is $170,000. The difference of $62,000 is more than six times the initial investment itself. Over the past decade, that a two-percentage-point differential I chose in my book characterized almost exactly the spread between a low-cost S&P 500 index fund (+14.4% per year) and the average U.S. stock mutual fund (+12.3%). Final value of an initial investment of $10,000: Index mutual fund $38,400; Managed mutual fund $31,900. And, I should note, that substantial increase in reward came hand-in-hand with no increase whatsoever in risk. In fact, the index fund was some 15% less volatile than the average equity fund.

Average Equity Mutual Fund % of Average Assets 1. Advisory Fees 1.1% 2. Other Operating Expenses 0.5 Total Expense Ratio3 1.6% 3. Transaction Costs4 0.7 4. Opportunity Cost5 0.4 5. Sales Charges6 0.6 Total 3.3% 6. Taxes7 1.6 TOTAL 4.9% You don’t need me to tell you that 330 basis points—490 basis points if we include even a modest estimate of taxes—is a lot of Embedded Alpha. Now let me show you how all of this works out in practice. First, to be conservative, I’m going to slash that 330 basis point charge, first by ignoring the 60 basis points for sales charges (which are ignored in most industry performance data), then by using an expense ratio weighted by fund assets (another 50 basis point drop), reducing costs to 220 basis points. Let’s use that conservative figure as a benchmark for the Embedded Alpha of the average fund. Next, I’m going to assume that funds earn average returns equal to those of the stock market itself. Of course, managers have the opportunity to earn higher returns (or, for that matter, lower returns) than those of the market. While my own data for the past 15 years suggest that, before the deduction of all that Embedded Alpha, the average fund actually outpaced the stock market (Wilshire 5000 Total Market Index) by 50 basis points per year, these data include only the records of funds that survived the period. (And, believe it or not, only about one-half survived.) So a market matching return seems not only fair, but generous.

returns.1 Hence, my projection of 7 percent annual return for stocks (2 percent current dividend yield, 5 percent annual earnings growth, with no significant impact from speculative return). Investment Costs But don’t expect to earn that return, for it represents the gross return on the market before the deduction of investment costs. How much do costs matter? Enormously. If we conservatively assume investment costs of 1 ½ percent per year, and begin with a $1,000 investment when the S&P 500 Index began in 1926 (Chart 2), a cost-free investment would be valued (with reinvested dividends) at $3.5 million today. But after deducting those costs, the remaining value would be about $1 million, some 70 percent less. While investment costs of 1 ½ percent per year may sound inconsequential at first glance, the results are staggering when compounded over an investment lifetime. Note also that the burden of costs accelerates over time, consuming 40 percent of the S&P 500’s return by 1960, 54 percent by 1980, and 65 percent in 2000. As I’ve often observed, the magic of compounding long-term returns is overwhelmed by the tyranny of compounding costs. Investment Returns—Before and After Costs 1,000 10,000 100,000 1,000,000 10,000,000 1926 1940 1960 1980 2000 2012 S&P 500 After 1.5% Investment Costs $3.55 million $1.05 million Annual Returns Gross Return: 9.9% After Costs: 8.

In my thesis, I disagreed with the master. In a much larger mutual fund industry, I argued, professional investors would come to focus on the wisdom of long-term investment rather than the folly of short-term speculation. (I was surely right about the industry’s bright prospects! That $2 billion industry of 1951 is today a $12 trillion behemoth.) After reaching peak turnover of 140 percent in 1929, I predicted that fund managers would behave as “steady, sophisticated, enlightened, and analytic” investors, focused on enterprise—on corporate performance and intrinsic value—rather than momentary and evanescent share prices. Alas, fund managers turned out to behave in the reverse; “volatile, unsophisticated, unenlightened, and superficial.” Call it Keynes 1, Bogle nothing. Indeed, I have often said, after Oscar Wilde’s definition of the cynic, that our industry’s security analysts too often “know the price of everything, but the value of nothing.”

All of these fund expenses, plus fees paid to hedge fund and pension fund managers, plus advisory fees and trading costs and investment banking fees and all the other costs will total about $528 billion this year. (Chart 1) But don’t forget that these costs recur year after year. If the present level holds for the next decade (I’m guessing that it will grow), total intermediation costs would come to a cool $5 trillion. (Just think about these cumulative costs in the context of the $16 trillion value of the U.S. stock market and the $14 trillion value of the bond market.)

Every three years thereafter, assets would double again and again with remarkable regularity. In 1983, to $6 billion; 1985, $12 billion; 1986, $24 billion; 1989, $50 billion; 1992, $100 billion; 1995, $200 billion; and again to $400 billion in 1998. Remarkable! While it took longer—seven more years—for our assets to double yet again, we crossed the $800-billion mark in 2004. Today we oversee $1.1 trillion of other people’s money. Surely that growth can be described as a commercial success for our firm. More importantly, Vanguard has also proved to be an artistic success for our fund shareholders. The returns earned by our funds are consistently ranked near the top of our industry, most recently as #1 by Global Investor. How could it be otherwise? For this is an industry where cost is everything. After all, for investors as a group beating the stock market is a zero-sum game before the huge costs of financial intermediation, that a loser’s game after deducting those costs. These relentless rules of humble arithmetic, using Justice Brandeis’s formulation, backed by our mutual structure and our legendary thriftiness, guaranteed that we would be—as we are, by a huge margin—the world’s lowest-cost provider of financial services.and

” While all of this gratuitous advice from a callow college senior was, alas, largely ignored by the fund industry, the creation of Vanguard as a truly mutual mutual fund group—operated on an “at-cost” basis for the benefit of its owners rather than its managers—was my attempt to walk the walk that I talked the talk about all those years ago. Today, I assure you that my youthful idealism remains intact. Indeed, it is shamelessly reflected not only in Vanguard, and not only my Battle book, but in my new book, The Little Book of Common Sense Investing, both of which express—in different ways—my concern about our business and finance system, where so much has gone wrong. It is truly astonishing how pervasive have been the failures in our capitalistic system. While it’s often alleged that these problems have been limited to just “a few bad apples,” the evidence suggests that the barrel that holds all those apples, good and bad alike, has developed some serious problems. For example:  Yes, there have been “only” a few Enrons, WorldComs, Adelphias, and Tycos. But during the past five years, there have been 5,989 restatements of earnings by publicly- held corporations, with stock market capitalizations aggregating more than $4 trillion, often reflecting overly aggressive accounting procedures.Motors)

But these agents, beset by conflicts of interest, have failed to place front and center the interests of their principals, passively ignoring the need for good governance and allowing corporate managers to look primarily to their own interests. As the economists would say, investment America has an “agency problem.”  Two, the rise of short-termism. Institutional money management, once an own-a-stock industry (holding an average stock for six years during my first 15 years in this field) has become a rent-a-stock industry, now holding a typical stock for but a single year, or even less. That sea change caused us to forget about the importance of good corporate governance. When owners are investors, they must care, and care deeply, about the rights and responsibilities of corporate governance, and must exercise those rights and honor those responsibilities.stocks,

approval the SEC’s 1940 call on mutual funds to serve as “the useful role of representatives of the great number of inarticulate and ineffective individual investors in corporations in which funds are interested.” Fixing the System What we need to fulfill that promise of responsible corporate citizenship—shareholder democracy, if you will—does not require radical change in the existing institutional structure. But we must seek to muster the courage to address the two principal issues involved in what has come to be called “shareholder access” to the ballot—the company’s proxy statement. The first issue is the ability of owners to mount electoral challenges to independent directors.1 As the Supreme Court of Delaware noted in its 1984 Unocal decision, “If the stockholders are displeased with the action of their elected representatives, the powers of corporate democracy are at their disposal to turn the board out.” In a later case (Blasius Industries, 1988), Chancellor Allen added, “the shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.” Yet the cards in the deck of the proxy process are heavily stacked against the ability of owners to exercise their franchise. When the CEO controls the slate—and even when there is a theoretically-independent nominating committee—challenges to management-nominated directors have been rare.

stewards, of the corporate property entrusted to them. But when the CEO becomes not only boss of the business, but boss of the board, the concept of stewardship became conspicuous by its absence from the agenda of corporate America, and the traditional separation of powers between management and governance was abrogated. How will we restore that balance of power? If the directors aren't up to the task, well, shareholders will have to start acting like owners. While too many of our corporate stewards have failed to earn our faith, we mutual fund managers and our clients have, I fear, gotten the corporate governance that we deserve. For we have not acted as owners, focusing on corporate value and investing for the long-term. Rather, we have acted as traders, turning our fund portfolios over at an average of 110% per year, engaging in short-term speculation in stock prices. (We have been called, accurately I think, the "rent- a-stock industry.") Partly as a result, even after the great bear market fallout, the role of most giant institutional investors in governance has been conspicuous only by the sound of its silence. But to get the governance our shareholders deserve, we need to begin to act as good corporate citizens, recognizing that ownership entails not only rights, but responsibilities. This change will demand a major realignment of mutual fund priorities.

As the stock market bubble inflated, the mutual fund industry’s well-educated, highly-trained, experienced professional analysts and portfolio managers seemed blissfully unaware of what was going on in the financial statements of the companies into which their funds were pouring literally hundreds of billions of dollars. Somehow our professional investors either didn’t understand, or understood but ignored—I’m not sure which is worse!—the house of cards that the stock market had become. Astonishingly, even after the bear market that has devastated the value of the equity holdings of fund shareholders, the only response we’ve heard from the mutual fund industry is the sound of silence. Why? Because the overwhelming majority of mutual funds continues to engage, not in the process of long-term investing on the basis of intrinsic corporate values, but in the process of short-term speculation based on momentary stock prices. The typical fund manager has lots of interest in a company’s price momentum—its quarterly earnings and whether or not they are meeting the guidance given to Wall Street. But when it comes to what a company is actually worth—its fundamental earning power, its balance sheet, its long-term strategy, its intrinsic value—there seems to be far less interest. Yet focusing on the price of a stock— perception—rather than on the value of a corporation—reality—can hardly be a winning strategy over the long run.of

Awakening in the blackness, the first words I remember hearing were, “Congratulations. You have a new heart, and it is young and strong.” And so it was. It was also a near-perfect match. I’ve had 33 consecutive zeros on the rejection scale, have long ago ceased taking the most potent anti-rejection drugs, and am enjoying perfect health. With my miraculous second chance at life, I have the energy of a colt, play squash doubles a couple of times a week, again sail my aging 15-foot sailboat, enjoy my family, and take long walks with my wife. I’m also vigorously engaged in what has turned out to be my third career. For when my long tenure as a director came to an end as 2000 began, the Board, happily, agreed with my proposal that Vanguard would sponsor a newly-formed Bogle Financial Markets Research Center.to

And third, be cautious, and make certain each client understands the role of income as well as the role of capital appreciation, keeping in mind, not only the probabilities of earning high stock returns, but the consequences of assuming excessive risks. 2. Faith in Our Corporate Stewards I would note that caution is the order of the day not only because of the likelihood that we are facing an era of lower returns in the financial markets. We are also facing the huge challenge of helping our clients put their wealth to work productively because, in the aftermath of the bubble, they have likely lost faith in the stewards to whom we have entrusted the management of our corporations. Part of the problem is the mania that resulted in the recent bubble. As Edward Chancellor, author of “Devil Take the Hindmost: A History of Speculation,” reminded us, manias bring out the worst aspects of our system: “Speculative bubbles frequently occur during periods of financial innovation and deregulation . . . lax regulation is another common feature . . . there is a tendency for businesses to be managed for the immediate gratification of speculators rather than the long-term interests of investors.” And surely that’s what we’ve seen. Here’s how The New York Times described the Enron mess: “A catastrophic corporate implosion . . . that encompassed the company’s auditors, lawyers, and directors . . .and

And it seems inconceivable that the huge boost that investment returns received from the 1979 – 1999 increase in the price-earnings ratio from 7x to 30x—a speculative return of more than 7% per year!—can possibly recur. Indeed, it is reasonable to predict that p/e ratios, having added so much to previous stock returns, will now begin to subtract from them. That is, having seen the bright upside of speculative return, we are now seeing its dark downside. Reversion to the mean strikes again. Current bond yields of 6% set the stage for average bond returns at a roughly similar level over the next decade. And while today’s money market yields of about 2% can and will change, perhaps substantially, it would take some leap of faith to forecast a return to the earlier average. So, while I’m the first to admit that even the most reasonable expectations for future financial market returns may be wide of the mark—either way!—it seems sensible for both investment professionals and investors themselves to plan for an era of lower financial market returns.Not

Marching to a Different Drummer But while mutuality has been the key factor in Vanguard’s growth and in the Philadelphia Contributionship’s longevity alike, the concept is hardly winning any popularity contests. Part of the reason for my choice of the name Vanguard for our new firm was to suggest that our structure would establish a new trend, one that would lead the way in the mutual fund industry. Alas, after the passage of nearly 28 years, our mutualized structure has yet to attract its first follower. Indeed, in the insurance field, it is de-mutualization that is leading the way. Nearly all of the great mutual life insurance companies that once dominated their field have abandoned their heritage. And mutual thrift institutions—before its demise, even the venerable Philadelphia Saving Fund Society had converted to stock ownership—are today as hard to find as the cigar store indian.creating

The Wisdom of Investment In the quest to own the total stock market, the first index mutual fund was designed to replicate the results of the Standard & Poor’s 500 Stock Index. So, shortly afterward, was that original Samsonite pension account. That Index proved to be a marvelous choice. Yes, the S&P 500 is a large-cap index, but the U.S. stock market is a large-cap stock market, and the S&P 500 typically accounts for 70% to 80% of its market capitalization. Yes, the 500 was dangerously exposed to technology (34% of its value) as the great bubble reached its maximum inflation in March 2000, but so was the U.S. stock market. And yes, the S&P committee that adds stocks to and deletes stocks from the Index has often seemed to select the hottest stocks of the day, but the fact is that it is simply keeping the Index in synchronization with the largest stocks of the day. Indeed, it is estimated that a portfolio simply owning the largest 500 stocks in our marketplace would carry a long-term correlation of something like 0.999 with the S&P 500 Index. Two facts may surprise you: First, the long-term correlation of returns between the Standard & Poor’s 500 Stock Index and the total U.S. stock market (measured since 1926 by the University of Chicago’s Center for Research in Security Prices—CRSP—and since 1972 by the Wilshire 5000 Index) is a remarkable 0.98%.

The Mutual Fund Industry—Meeting Investor Needs? My outlook for financial market returns suggests that the long and exciting voyage of the stock market is unlikely to get less adventurous. We not only live in a risky era, but an era in which lower returns in the financial markets, across the board, seem the order of the day. But please don’t make the mistake of assuming that those are the returns investors will actually receive. The fact is that few investors indeed ever have received—or ever will receive—the returns that the markets provide. This brings me to yet something else we know: Since all investors as a group garner the gross returns of the market, beating the financial markets is a zero sum game. And since investing costs money—lots of it!—all investors as a group lose to the markets by the exact amount of their costs, and beating the markets quickly becomes a loser’s game. Because of the staggering costs imposed by financial intermediaries, the lag in investor returns is substantial. Consider the mutual fund industry. Fund advisory fees and operating expenses this year will come to about $70 billion; sales charges and out-of-pocket costs, another $5 billion; the hidden—but real—costs of portfolio turnover, another $35 billion. Total $110 billion. What is more, despite the industry’s staggering growth, these costs have soared even faster, for only a tiny portion of the huge economies of scale involved in fund operations have been shared with investors.

Including the costs of soaring portfolio turnover—up from about 20% to nearly 100% annually—and sales charges, fund all-in annual costs now could well reach as much as 3.3% per year. But even at 2½% of assets per year, fully 25% of an assumed 10% stock market return would go to the intermediaries rather than the investors. The industry’s shortfall to the stock market during the past three decades appears, not surprisingly, to be a directly comparable—and largely causal—2.9%, double the 1.5% shortfall that I calculated by hand in 1975 from old industry by manuals during the pre-information age. Those rising costs are the principal reason that fund performance in the Information Age is not far better. It is far worse. And, yes, costs do matter. Just compare an assumed market return of 10% with a mutual fund return of 7½%—10% gross stock market return minus even 2½% expenses—for a tax- deferred retirement plan in which $5,000 per year is invested over 40 years: Final value of the actively-managed mutual fund investment, $1.1 million. Final value of the passive stock market investment, $2.2 million. Two to one.knew

’ And so I look at the de Tocqueville Award not only as recognition of the past, but as an encouragement—indeed a challenge—to do even more through our United Way, in the future years I am given.” In striving to live up to that promise, I joined the de Tocqueville million-dollar round table in 1995. It took me nearly six years to complete my pledge, but I just wrote my final check over the weekend. It’s a privilege to have made that commitment, and a delight—and a relief!—to have fulfilled it. I’ve felt strongly enough about the United Way to have put Vanguard’s weight behind it almost from our very inception in 1974.Vanguard-wide

America’s Treasure Whatever one person may have accomplished in their long life, please realize that you can do greater things. For who really knows what will follow when you commit yourself? Truth told, if our land of liberty is to continue to realize her awesome promise, you must surpass the achievements of your elders. Do not sell yourselves short. You members of the Class of 2001— the first college class of the third millennium, all over our nation—are truly America’s treasure. Hear Woodrow Wilson: The treasury of America does not lie in the brains of the small body of men now in control of the great enterprises . . . It depends upon the inventions, upon the originations, upon the ambitions of unknown men and women. Every country is renewed out of the ranks of the unknown, not out of the ranks of the already famous and powerful in control.

” Their wisest member, a sage old uncle, softly responds: “All that money you’ve paid to those Helpers and all those unnecessary extra taxes you’re paying come directly out of our family’s total earnings and dividends. Go back to square one, and do so immediately. Get rid of all your brokers. Get rid of all your money managers. Get rid of all your consultants. Then our family will again reap 100 percent of however large a pie that corporate America bakes for us, year after year.” They followed the old uncle’s wise advice, returning to their original passive but productive strategy, holding all the stocks of corporate America, and standing pat . . . and the Gotrocks Family Lived Happily Ever After. Business Reality Trumps Market Expectations That wonderful parable brings home the central reality of investing: “The most that owners in the aggregate can earn between now and Judgment Day is what their business in the aggregate earns,” in the words of Warren Buffett.out-sized

Only a few decades ago, it was the investment committee that managed the fund and focused on the long-term, but today it is the portfolio manager that is in charge. Portfolio managers, focusing on the short-term, can be “hot,” and when there is heat, huge capital inflows are not far behind. And larger assets mean larger fees. So, ever since the mid-1960s, we’ve lionized our hot portfolio managers; they became our stars, glamorous and glittering. “A star is born” has become the watchword. Alas, as we now know, most stars have proved to be comets, illuminating the financial firmament for but a few moments in time and then burning out, their ashes gently descending to earth.

Yet we all know, more than ever in this new age of information, that a well-educated populace is the very foundation of democracy. And I speak not only of the universal education sought by Adam Smith in The Wealth of Nations, education in the applied mechanics of modern life, reading, writing, and arithmetic, craftsmanship, and now computer literacy. Important, indeed essential as they are, we need more than that. We need a populace with at least a passing familiarity with history, philosophy, and literature; the entire panoply of the liberal arts. And citizenship, values, and ethics too. For lacking moral purpose, even a liberal education will fail to perpetuate the great values of our Founding Fathers that led to the Declaration of Independence and the Constitution, those instruments of scholarship, creative imagination, and moral genius that have served our nation so well for more than two centuries. How, you ask, are we to respond to this huge challenge? There is only one truly American answer: Together. Together, business, academia, the professions, government—we the people—must work to build a more perfect Union, beginning with our public school system.

Today, we have a new mutual fund industry, one that is distinctly different from its staid, largely conservative ancestor—in variety, in concept, in investor participation, in service quality, and in pricing. But the question is: Do we better serve investors? A New Industry Emerges Surely there are more fund choices. The number of mutual funds has exploded, providing investors with an enormous variety of fund objectives, strategies, and managers. Just 20 years ago, the old industry was composed of fewer than 300 equity funds—the embattled survivors of the great 1973-1974 bear market, licking their wounds. The new industry comprises a bewildering total of some 7,300 funds—not only 4,000 equity funds, but 2,200 bond funds and 1,100 money market funds as well.as

Within this structure, in our service-profit chain the profits of investing go to our shareholders. As the world has slowly come to learn: costs matter. Costs matter because the benefits of lower costs are huge: a 100 basis point advantage applied to our $500 billion-plus asset base produces annual savings of $5 billion for shareholders. Costs matter because they represent a diversion of the returns of the financial markets from investors to investment managers. (Where are the customers’—or should I say, clients’—yachts?) And costs matter because lower costs lead directly to higher returns—a link that is readily calculable. Investment Strategy and Low Cost The magic of low cost—and it is no less than magic—is the core of our service-profit- stewardship mission, a crucial link in the chain. For our long-term investment philosophy, combined with our simple investment strategies, depends on cost-effectiveness. We are the innovators of the two investment strategies that have come to dominate our asset base, now representing $350 billion, or nearly 70% of our $500 billion-plus total (Chart 6).difference

50%, his profits would be gone, and the impact on the market would be no more than minimal. And at 0.20%, the manager would probably be bankrupt. So the manager of Fund A doesn’t reduce his 2% expense ratio. Price competition is defined, not by the behavior of consumers, but by the actions of producers. What would real price competition look like? The answer is as simple as it is obvious. Since Vanguard’s success has been based on long-term investing at low-cost, competitors would have to: (i) cut their management fees and the portfolio turnover of their managed stock and bond funds; and (ii) plunge enthusiastically into the index fund fray; a “kicking and screaming” entry won’t do the job. These changes would make money for their investors. But they would slash profits for their management companies (and their shareholders), for it costs managers money to give shareholders the fair shake they deserve. The simple economic truth is this: As long as today’s awesome level of profitability is priority number one for the managers, fund shareholders will pay the price, and industry expense ratios will continue to edge ever upward.Advisers

Our CDs and money market funds will yield less simply because the costs of financial intermediaries-transaction costs, information costs, and the cost of convenience-will be deducted from the interest rates paid by the government or corporate borrower. Similarly, we do not-nor should we-expect our bond funds to provide us with higher yields than the average yield of the bonds held in a fund's portfolio. In fact, in bond funds as a group, because of grossly excessive fund fees, most bond funds provide-not 100% but only 75%. The fact is that nearly all bond funds are distinctly inferior investments. Yes, and even in the equity arena, it is simply a mathematical impossibility-a definitional contradiction-for all investors as a group to reach 100% of the stock market's annual returns-maybe 85% on average.certainty

With the extraordinarily low operating expenses that became our hallmark—a product of our mutual structure and our cost discipline—offering our shares without sales commissions proved a timely step. Our fundamental marketing strategy: “If you build it, they will come.” (A phrase, of course, that inspired the creation of a baseball diamond in Iowa.) And, though it took years to happen, come the investors did. By the millions. The diamonds Vanguard had accumulated during those struggles, however, were not yet quite ours. They were only on loan. The Securities and Exchange Commission gave us only a temporary order allowing us to take some of these crucial, but unprecedented steps. And finally, believe it or not, the SEC concluded that we could not do so. Aghast, for I knew we were doing what was right for investors, we endured a week-long regulatory hearing, mounted a vigorous appeal, and—after a struggle that lasted four years—triumphed at last in 1981, when the SEC did an about face and finally approved our plan. The diamonds weren’t going to Boston.Wellington

If there are long odds against outpacing the market, at least going about the task of fund selection intelligently can help you to insure against a significant failure. So let me give you nine rules that may help you to do just that. Rule 1. Select Funds With Low Expense Ratios I’ve said “costs matter” for so long that the portfolio manager for one of our funds gave me a Plexiglas pillar with the Latin translation: Pretium Refert. But costs do matter, and their impact will likely grow in importance in the ears ahead. It is costs, pure and simple, that have accounted for—and will continue to account for—the lion’s share of the shortfall of the typical mutual funds in the stock market. The industry’s estimated 2 ½% annual cost, for example, would consume fully 15% of a market return of 17 ½%, leaving 85% for you. That portion will rise when returns revert to lower levels. That same cost would consume 25% of a market return of 10%. And if the going got really tough, say, in a 5% market, fund costs of 2 ½% would confiscate fully 50% of the market return, leaving only 50% for the investor.

(It is this recent history—covering but 8 of the entire 60 years—that has created the value stock mystique.) Then, growth stocks outperformed through 1980, and value stocks have pretty much dominated since then. Linking all of these cyclical fluctuations, as reflected in Exhibit IV, for the full six decades, the terminal investment in value stocks was equal to about nine-tenths of the growth stock investment. For the full 60-year period, the compound returns were: growth, +11.7%; value +11.5%. I’d call that match a standoff, and a tribute to RTM. My second example of market sector RTM is high-grade versus low-priced stocks. This series— not much considered by investors during the past decade—has been published by Standard & Poor’s Corporation on a consistent basis since 1926. Here, as shown in Exhibit V, the swings in market pre- eminence are much briefer than with growth and value stocks. The most sustained trends have been evident during the past four decades, with low-priced stocks enjoying a six-year feast from 1962 through 1968, followed by a complete reversal in favor of high-grade stocks, a six-year famine that lasted through 1974.

Once upon a time, managers could (and did) use the argument, “yeah, but who can buy the market?” And later, “yeah, but the index is theoretical, and it would cost a lot to buy, be expensive to operate, and you wouldn’t be able to nearly match the index.” The low- cost index fund has given the lie to these foolish make-weight arguments. But even though Vanguard founded the first index mutual fund began in 1975, fully 22 years ago (perhaps the bogle goblin really was the data devil), it was not until the mid-1990s that index funds began to catch the fancy of investors and become a formidable competitor for their assets. And tough competition they are. As recently as 1994, index funds accounted for only 3% of equity fund flow ($4 billion). In 1997, index fund inflow should reach a 15% share ($30 billion). What is more, tough in the marketplace they should be. For they have been tough in the market. As I noted at the outset, the total return on the original S&P 500 index fund (net of costs) over the past 15 years was 18.2% annually, compared to 15.7% for the average U.S.equity

What is more, external circumstances could exacerbate the situation. A market decline which caused net liquidations would increase per share distributions. Conversely, rising markets, which bring in new money at ascending prices, dilute per share distributions. That is why mutual fund unrealized gains have been small relative to the rise in stock prices. Curiously, investors don't seem to mind paying $10.00 per share for a fund with a tax liability on, say, $2.50 in unrealized capital gains. In a down market, when share prices tumble, it is possible, if not likely, that new fund investors with unrealized losses would nonetheless receive substantial taxable capital gains distributions. (Fund accounting practices give rise to strange outcomes!) "Forewarned is forearmed." With all this background, let's look at tax impact in a longer-term context. On the income distribution side, the tax impact is, in a perverse sense, beneficial. Equity mutual funds are today earning gross income before expenses-at the rate of about 2.1 %. (Their equity holdings yield about 1.7%; their 7% average reserve position 6%.) But fund expenses average 1.5%, meaning that equity fund investors receive a puny 0.6% yield on which to pay taxes. Expenses, in fact, are consuming 71 % of fund income. In the paradoxical world of mutual funds, then, the higher the expense ratio, the more "tax efficient" the income component of total return. "Alice in Wonderland" writ large! Alpha Takes Another Hit ...

The board approved (9 to 2—a landslide for a change) our assumption of responsibility internally for our money market and bond funds in 1981. Slashing the expenses of these funds by doing the job ourselves at rock-bottom cost, we raised net income accordingly. Our resultant superior yields, combined with our existing strategies of peerless investment quality and defined maturities, has made us the dominant force in the fixed-income fund field today. So by 1981—just six years after we began as a tiny administrative business—we had become the full-fledged mutual fund organization that I had sought to become, without success, in 1974. The modern Vanguard was in place. There was, really, just one more action we took that established the firm that the world knows today, and that was our very first action after we got up and running in 1975. We formed the first index mutual fund. The Inescapable Logic of our Index Fund I’ve always had a bit of an intellectual bent to go with the opportunism and determination that were required to conceptualize, form, and develop the full Vanguard structure. As an avid reader of the academic journals, I had become intrigued by the concept of index investing, and had watched it gain a toe-hold among a few banks and pension funds during the mid-1970s. The idea of index investing was simply to match the market and, by keeping costs at minimal levels, to winning the game in the long-run.of

When compounded over 10 years, the advantage is huge; over 25 years it soars; and over 50 years the advantage is truly stratospheric. I should note that 50 years is not an unrealistic period to consider; indeed it is no more than a “working lifetime” for an investor who begins to invest in a 401(k) tax-deferred savings plan at age 25 and is living off of the fruits of his accumulation at age 75. The figures speak for themselves: Exhibit V: Cumulative Impact of Costs on a $10,000 Investment (High Cost) (Low Cost) 10.0% 12.3% 10 Years $25,900 $31,900 25 Years $108,300 $181,800 50 Years $1,173,900 $3,303,600 Now, I’d like to turn to the implications of costs for asset allocation policy, focusing on the relationship of long-term stock returns and bond returns.

The biggest risk is the long-term risk of not putting your money to work at a generous return, not the short term--but nonetheless real--risk of price volatility. Even though stocks seem very high, consider what I said in my book “never think you know more than the market does.” You’re apt to be wrong. Second, give yourself all the time you can. At the extremes, if you’re in your twenties, begin to invest in stocks even if you only have a small amount to invest; if you’re in your sixties, invest more in bonds and less in stocks. Compound interest is a miracle, and time is your friend.market

(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

From the March high last year to the April low this year, the NASDAQ Index has plummeted 67%, while the listed market, as measured by the NYSE Index, is now but 4% lower. After departing far from normalcy, then the relationship has returned to normalcy with a vengeance. The little brother is little again. And that eternal rule of the financial markets—reversion to the mean—has again asserted its time-honored force. And what about those metrics? Well, the price/earning ratio of the S&P 500 has tumbled by 37%, from 32 times to a more realistic (if still historically high) to 20 times. The value of stocks in relation to GDP has dropped from 180% to 124%. And those nine big-cap tech stocks singled out by Dr. Siegel, were a sucker’s bet. More than one trillion dollars(!) has evaporated from their combined market value—a drop from $1.6 trillion to $570 billion. And their median price-earning ratio is now down to 47 times—hardly cheap, but hardly ridiculous either. Reality—or at least some version of reality—has now returned to the stock market.

Intertek’s score increased due to questionable criticism from the Clean Clothes Campaign for not promoting workers safety enough, while Waters’ increase was due to an article in Korea reporting that some scientific instrument sellers were fined for bid rigging in government contracts that Waters was mentioned in despite not receiving a fine. Both of these are good examples to show that the RepRisk Indicator, whilst generally a good proxy for negative impacts, can be misleading in some situations. As such, we didn’t give either of these score increases much weight in our investment view of the companies. Those of you with a keen attention for detail and who read our monthly ESG factsheet each month, will have noticed that we changed the Environmental statistics to means rather than medians from March this year. This places more weight on companies that have large negative impacts. The number of companies reporting basic environmental stats is still very poor. On average only 35% of S&P 500 companies report the amount of waste, water and energy they use or the amount of CO2 they emit compared to 68% for the Fundsmith Sustainable Equity Fund investable universe. We suspect this is because the companies we invest in tend to have a lower negative impact on the world and therefore are more likely to disclose environmental statistics.

What could possibly explain this huge differential? Could these fund directors possibly be shouldering eight times the responsibility shouldered by their corporate counterparts? Consider the facts: A corporate director is responsible for approving the corporation’s policies and business objectives; selecting the chief executive officer; approving multi-million dollar expenditures on plant and equipment; determining an appropriate capital structure, dividend policy, and stock repurchase program; and, typically, approving a mission statement focused on the creation of long-term economic value for the corporation’s shareholders, measured by returns that are higher than the corporation’s cost of capital. Money Market Fund Expenses For A Major Fund Complex Total Assets: $61 Billion Investment Management: $ 254 $ 10 Distribution: 64 64 Shareholder Services: 71 71 Total: $ 389 $ 145 Annual Fees Est’d. Ann. Expenses $ Million Chart 7.

Now let’s look long-term. Despite today’s environment of frighteningly short-term investment horizons, most investors start their programs with their first $1,000 in an IRA or 401(k) and will still be investing, not 50, but 70 years hence. I’ll use 50 years. What toll would a 3 Unweighted mutual fund ratio. The weighted ratio is about 1.1%. 4 Most studies show far higher transaction costs. But since market impact itself must be a net zero, (i.e., your aggressive sale creates my bargain purchase), my low estimate reflects how much “The Street” charges for its trading services. 5 Assuming 12% stock return; 6% cash return; 7% of assets in reserves. 6 5% sales charge, amortized over ten-year holding period. 7 Assuming 10% fund after-cost return, 1% income, 9% capital; 50% of gains realized annually, two-thirds long-term, one-third short-term; maximum tax bracket.

For the companies in our investable universe that don’t report environmental stats, we have always estimated them by looking at the average per £m of assets for the company’s respective subsector for each environmental stat we report and then scaling that number up for the assets of the individual company. From March, we also started doing this for the S&P 500 environmental stats to give a more accurate comparison for our portfolio. Johnson & Johnson (J&J) has consistently had the highest RepRisk indicator (RRI) of any company in the portfolio since we launched the Fundsmith Sustainable Equity Fund. It started the year with an RRI of 66 and finished it with a slightly lower score of 58. The majority of that score comes from the risk associated with the safety of their products, whether J&J accurately represented those risks and publicity from US court cases and settlements. When a company has a high RRI it can be, but isn’t always, an indicator that the company has a large negative impact on the environment or society. However, it can also indicate there has been a lot of media coverage around a specific story where the headlines and the details tell different stories. J&J’s lawsuits, which are the main driver of its high RRI score, mainly relate to whether it misrepresented the safety of its products in its marketing.

Since I came into this industry 50 years ago, fund assets have grown by more than 200,000%(!), from $3 billion to $6.5 trillion. Yet the expense ratio of the average equity fund, then about ¾ of 1% per year, has more than doubled, to 1.6%. Fund portfolio turnover, 18% annually in those ancient days, has risen to more than 100%, far larger than the decline in unit costs that our highly-efficient electronic stock markets have provided, and leading to an additional, say, 0.7% of annual costs. Together, these two costs alone come to 2.3%. Add in fund sales charges and other fees, and a 3% all-in cost hardly seems hyperbolic. All else held equal, then, equity fund returns should lag the stock market return by about 3% per year. From Theory to Practice Practice confirms theory. Since 1984, stocks, as measured by the S&P 500 Index, have provided a 16.3% return. The average equity mutual fund turned in a return of 13.1%—3.2

Fund turnover has risen from about 15 percent during my first 15 years in this business to 100 percent in recent years, reflecting a trend toward speculation that has been growing since the mid-1960s. Total turnover on the New York Stock Exchange was also less than 20 percent through the mid-1960s. Even by the mid-1990s, it rarely exceeded 50 percent. But in 2007, stock turnover exceeded 200 percent per year. If we include the trading in exchange traded funds (ETFs), that number has now soared to 280 percent, double the 1929 level. Clearly, the nature and character of our equity markets have changed. We are in a new era, one with the highest speculation component in history. How Did We Get Here? This soaring volatility in our financial markets—what I’ve described as “an orgy of speculation”—is a product of many forces. Surprisingly enough, one is the institutionalization of the stock market. The change is dramatic: Over the past half-century, individual ownership of stocks by individual investors has dropped from 92 percent of the total to 26 percent. Institutional ownership—largely by mutual funds and corporate and government pension funds— has soared from 8 percent to 74 percent—quite literally, a revolution in stock ownership that has changed the nature and structure of our financial markets.

Unlike those staid old committees, the new breed of manager was lighting-quick on the trigger. The portfolio managers just can’t seem to sit still for very long, echoing Pascal’s maxim: “All human evil comes from this, from man’s inability to sit quietly in a room.” What is more, the managers don’t hold their jobs for very long, and considerable portfolio turnover arises simply from portfolio manager turnover. The average manager of an equity fund with at least five years of operations is but six short years, and when he or she moves on—a failure, or such an ostensible success that the hedge fund sirens beckon, or simply a reorganization of the investment department—the broom of the new manager sweeps the portfolio clean. What’s so evil about this turnover frenzy? First, it cannot possibly serve fund investors as a group, because as much as half of all turnover—perhaps even more—takes place among mutual funds themselves. Second, it costs money to trade securities—commissions, spreads, and market impact costs—conservatively estimated at one-half to one percentage point per year of return. Third, its tax impact is, well, devastating. Capital gains, about one-third of which are realized on a short-term basis and thus taxed as ordinary income—have resulted in a hit to fund returns of almost three full percentage points of return each year during this bull market.

benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.” How often investors lose sight of that eternal principle! Yet the record is clear. History, if only we would take the trouble to look at it, reveals the remarkable, if essential, linkage between the cumulative long-term returns earned by business—the annual dividend yield plus the annual rate of earnings growth—and the cumulative returns earned by the U.S. stock market. Think about that certainty for a moment. Can you see that it is simple common sense? Need proof? Just look at the record of stock returns over the past 100 years. The average annual total return on stocks was 9.6 percent, virtually identical to the investment return of 9.5 percent—4.5 percent from dividend yield and 5 percent from earnings growth. That tiny difference of 0.1 percent per year, arose from what I call speculative return. Depending on how one looks at it, merely statistical noise, or perhaps it reflects a generally upward long-term trend in stock valuations, a willingness of investors to pay higher prices for each dollar of earnings at the end of the century than at the beginning. Compounding these returns over the century produced accumulations that are truly staggering. Each dollar initially invested in 1900 at an investment return of 9.5 percent grew by the close of 2005 to $15,062.

Mutual fund directors are responsible for none of these decisions. Rather, in the industry’s own parlance, they are “watchdogs” for each of the 100-300 funds usually managed by the large fund complexes, approving (and rarely, if ever, disapproving) each fund’s advisory and distribution contracts, custodian agreements, and pricing and valuation procedures; and monitoring investments and portfolio quality and liquidity—part of a seemingly imposing list of 40 duties set out by the industry, but duties that, in the real world, are largely perfunctory. None of these duties, moreover, relates to a fund’s mission and its obligation to create economic value by earning the cost of its capital. Further, those approvals and that monitoring take place under the direction of the fund’s chairman—a chairman who is, almost without exception, also the chairman (or a high official) of the fund’s management company. The chairman controls the agenda; the staff reports are made by his subordinates; the responsibilities for management are theirs alone. It’s simply not reasonable to attribute the vastly higher fees paid to these independent fund directors to their having assumed vastly higher responsibilities than their management company counterparts. That leaves us with at least the possibility that such high fees are there to subtly encourage directors to act at the manager’s behest.

creating the first index mutual fund was exciting. It wouldn’t involve “investment management” for our new firm. The board had decreed that as a taboo at the outset. But I knew absolutely that “non- management” had to work. An “at cost” operation like ours could make the most of the opportunity, and we grabbed it. So, when Vanguard finally began operations in May 1975, we quickly developed a plan for the formation, management, and distribution of the first index mutual fund in history. The board (again, after considerable controversy) approved it four months later in September, and it was incorporated in December of the same year. Then named “First Index Investment Trust”—though known more familiarly in the industry as “Bogle’s Folly”—the fund began operations with $11 mission of assets in August 1976. It’s had a good run, solidly outpacing the returns of actively-managed funds. And the now-well-known 500 Portfolio of the renamed Vanguard Index Trust, with assets nearing $50 billion, is the second largest mutual fund in the world. It constitutes about one-half of our index book of business of 26 passively-managed stock and bond funds, now approaching $100 billion in assets. These assets, in turn, comprise nearly one- third of our $300 billion asset total today. Standing alone, our index funds would be the nation’s seventh largest mutual fund complex. All in all, it wasn’t too bad an idea.

We are accustomed to thinking of fund expenses as a percentage of assets—in the mutual fund field ranging from 0.2% of assets annually for the lowest-cost equity funds (often, as it happens, market index funds) to 1.5% for the average fund, to 2.2% for high-cost funds (those in the top expense ratio quartile). Too rarely—although I’ve urged the SEC to mandate this concept in prospectus disclosure—expenses are thought of as the percentage of an initial investment consumed over ten years. Here, the range would be 2.8% for the lowest-cost funds, 19.8% for the average, and 28.1% for the high-cost funds. That is to say, a 0.2% annual cost on an investment of $10,000 costs $280 over ten years compared with $2,810 for a fund with annual costs of 2.2%. (As you can imagine, our industry is not particularly smitten by this concept, for it brings the cost issue into sharp relief.) Costs can also be thought of in a third way—as a percentage of annual return on equities. Using the same examples and assuming a long-term market return of 10%, costs would consume 2%, 15% and 22% of annual returns, reducing the net return earned by investors to 9.8%, 8.5%, and 7.8%. This substantial drain is all too obvious, even as it is all too infrequently referenced. But it is a stark fact of investment experience. And now is the time to introduce a fourth concept of costs, a new concept (at least one I have not seen before): cost as a percentage of the equity risk premium.

Among the thousands of publicly-traded firms, there were an average of just eleven challenges per year during 1996-2002. And only one(!) per year for companies with a market capitalization exceeding a mere $200 million. In Harvard Professor Lucian Bebchuk’s words, “the incidence (of challenges to incumbent directors) is practically zero.” Corporate managers, not surprisingly, strongly object to changing the system to facilitate challenges to their slate. The Business Roundtable warns that shareholder participation in the nominating process “has the potential to turn every director election into a divisive proxy contest,” involving heavy cost and the diversion of management effort. But even if that could happen, there is no reason that a well-designed access proposal couldn’t resolve most of the difficulties. Managers also argue that potential directors would be deterred from serving, but that 1 My ideas have been importantly informed by the fine analysis prepared by Lucian Bebchuk, Professor of Law at Harvard University School of Law, in “The Case for Shareholder Access to the Ballot,” The Business Lawyer, Volume 15 (2003).

they could hardly care less. Simply put, as I ask in the book, “If the owners of corporate America don’t give a damn about the triumph of managers’ capitalism, who on earth should?” Yet our new agent/owners remain passive to a fault on governance issues.  Three, the triumph of illusion over reality. As our professional security analysts came to focus ever more heavily on illusion—the momentary precision of the price of the stock—they increasingly ignored the reality—that what really matters is the inevitably vague, but eternally transcendent, intrinsic value of the corporation. (As investment icon Benjamin Graham, mentor to Warren Buffett, perceptively put it: “In the short run, the stock market is a voting machine; in the long run it is a weighing machine.”) Measuring up, unfortunately, to Oscar Wilde’s piercing description of the cynic, our money managers came “to know the price of everything, but the value of nothing.” But when there is a gap between perception—illusion—and reality—the business fundamentals of cash flow and dividends—it is, to state the obvious, only a matter of time until the gap is reconciled . . . inevitably, in favor of reality. In Mutual Fund America:  One, the industry changed. Mutual funds, once a profession with elements of a business, gradually became a business with elements—and too few elements at that—of a profession. Our traditional guiding star of stewardship was transmogrified into a new star— salesmanship.

fund. While this period was an especially fine one for the large cap stocks in the S&P, even a total stock market index fund—the Wilshire 5000 Equity Index, adjusted to account for estimated costs—would have returned 17.7%, only 0.5 percentage points shy of the 500 and still an advantage of two full percentage points in annual return. (And that’s even before fund sales charges are taken into account!) The fact is that, at least in my judgment, the index fund should be the investment of choice. It is the odds-on (pardon another expression from the world of gambling) favorite to win the race (another!) against three of every four managers. We know that, for the market as a totality, low-cost investing—which is really all that an index fund is about—ineluctably beats high-cost investing over the long run. And while I happen to prefer the all-market index because of its complete diversification and nominal portfolio turnover, I can’t imagine that the long-term return of the S&P 500 Index, comprising as it does 70% of the market, will vary significantly from the return of the total market. In any event, the marketplace, now dominated by S&P 500 indexing, is increasingly moving in the direction of all-market indexing. I fully expect that over the next few years this broader strategy will become the principal choice for institutional indexers and fund indexers alike.

 Yes, the investment banking scandals involved “only” twelve firms, but among them were eight of the nine largest firms in the field. As a result of the investigations by New York attorney general Eliot Spitzer, they ultimately agreed to pay some $1.3 billion in penalties  Yes, similarly, there were “only” a handful of insurance companies involved in the bid- rigging scandals, also uncovered by Mr. Spitzer. But, again, they included the largest companies in the field: American International Group, Marsh & McClennan, ACE, Aon, and Zurich, all of which agreed to settle the litigation and paid billions of dollars in penalties.  And yes, while a few of the largest mutual fund managers were not implicated in the fraudulent behavior reflected in the market timing scandals unearthed by Mr. Spitzer and his staff in 2003, many of the 23 firms that were involved were giants, holding more than $1.5 trillion of investor assets, fully one-quarter of the fund industry’s long-term asset base. This disgraceful spectacle alas, was one of many examples of how fund managers placed their own interests ahead of the interests of the fund shareholders they were duty- bound to serve—the triumph of salesmanship and asset-gathering over the stewardship and integrity that were, poignantly the hallmarks of the industry when I joined it all those years ago.

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.

Continuing a cycle that seems to vaguely parallel the seven-year cycle of Biblical prophesy, the next feast for low-priced stocks lasted for nine years, through 1983, followed by a seven-year famine through 1990. But, when all was said and done, for the full seven decades, each $1.00 initially invested in high-grade stocks was valued at about 1.4 times the investment in low-priced stocks, exactly where it was at the end of 1927, a truly great year for the high-grade issues. Even including the distorting effect of that single opening year, high-grade stocks provided a historical return of +6.8%; versus +6.2% for low-priced stocks (excluding dividends in both cases). Now to my third example. One of the seemingly indestructible myths of investing is that small cap stocks outpace large caps over time. Having accepted this proposition, its proponents then explain why, in terms easily enough understood. “Why, small caps carry higher risks, therefore it follows as the night the day that they must earn higher returns.” This reasoning would seem to make consummate good sense, but in fact the cycles of small cap superiority have been relatively spasmodic, as shown in this historical chart. (See Exhibit VI.) From 1925 through 1964—a period of 39 years—small caps and large caps provided identical returns. Then, small caps more than doubled the large cap return through 1968.

everything but the value of nothing,” he could have as easily been talking about the typical fund manager. The Mutual Fund Barrel Clearly, if we are to return to a system of owners capitalism, the active participation of institutional investors is essential and the mutual fund industry must be involved. That will not be easy, for the deeply-flawed mutual fund governance barrel makes the corporate governance barrel seem pristine. Think about it: Fund independent directors in actuality have only two important responsibilities: Obtaining the best possible investment manager and negotiating with that manager for the lowest possible fee. Yet their record has been absolutely pathetic. They follow a zombie-like process that makes a mockery of stewardship. Able but greedy managers have overreached and tried to dip too deeply into the shareholders’ pockets, and directors haven’t slapped their hands. They have failed as well in negotiating management fees. “Independent” directors, over more than six decades, have failed miserably. Fee reductions mean nothing to “independent” directors, while meaning everything to managers. So guess who wins? I would not have the temerity to use such highly charged language. Those words were actually written by Warren Buffett in his recent Berkshire Hathaway annual report. Mr. Buffett is, of course, right. And I dare to add, “as usual.” Of course the managers win. For the chairman of the fund is almost invariably the head of the management company.

managed largely by the contemporary numeric standards of modern management. But at our core, at least through my idealistic eyes, our founding values remain largely intact, thriving on our commonsense mutual structure, on our simple investment strategies, and on eternal verities such as service to others before service to self, doing our best to hold high the belief that ethical principles and moral values must be, finally, the basis for any enterprise worth its salt. So yes, I’m reasonably comfortable—if hardly objective!— in my conviction that, Vanguard will remain the fully-realized manifestation of our original vision that it is today. What is more, we have made a positive impact on our industry—in direction, if hardly in magnitude—that will ultimately make the mutual fund industry a better industry than it is today. The Financial Markets But it was years before I founded Vanguard that I first engaged with our financial markets. (Until then, given our family’s circumstances, I was very familiar with large debts and threatening repayment notices, but knew nothing—zero—about investments.) But when I happened to open FORTUNE magazine in December 1949, I learned of the mutual fund industry for the first time. I was intrigued and inspired by the prospects of this then “tiny but contentious” industry, and wrote my Princeton thesis about it. The thesis, in turn, led directly to my first full-time job in the summer of 1951—with Philadelphian Walter L.

As these costs are ranked from the table of the market casino, the croupiers with the largest rakes are the fund managers. The fees and expenses you pay to them are rising even faster than the industry’s soaring asset base. Since 1980, the expense ratio of the average equity fund has risen from 0.96% to 1.52%—a 58% increase. But, yes, larger fund groups have lower costs. For example, in the fair city of Boston, the expense ratios of the three largest fund managers—together managing a cool $1 trillion of fund assets—average 1.09%. But despite the awesome growth of these firms, that figure is far high than their 0.64% average expense ratio in 1980, a leap of 70% that is even larger than the 58% increase for the industry as a whole. “Big Money in Boston” all over again! It is high time that this industry does something to reverse this steady uptrend. And it’s not impossible. During that same 20-year span, one large fund firm has in fact gradually, but substantially reduced the costs paid by its investors. There ought to be a lot more firms doing precisely that. You owe it to yourself to select from among funds where the manager-croupiers exercise at least some restraint, evidenced by expense ratios that are well below industry norms. Rule 2. Emphasize Funds with Low Portfolio Turnover Once your money is invested in a fund, the rake of the next croupier begins to sweep.

come, working with the press and on television, regularly meeting with Vanguard crewmembers, and acting as a sort of ambassador to our shareholders/owners around the country. But perhaps the most rewarding part of my third career is the opportunity to apply my unflagging missionary zeal to the building of a better financial world. As I wrote years ago, investing is an act of faith—faith in our financial markets, faith in the stewards who manage our corporations, and faith in the trustees who invest our hard-earned assets. Given the events of the past few years, it can be no surprise that in each case investors are losing faith—and with good reason. So my new efforts focus on rebuilding faith in investing, on making the mutual fund industry a better place to invest, and on restoring the traditional values of Corporate America. In a sense, I have come full circle, for that very same 1949 issue of Fortune that included the mutual fund story also carried an extensive essay entitled, of all things, “The Moral History of U.S. Business”—one more marvelous coincidence. I take on these challenges with the same idealistic spirit that Fortune inspired in my ancient thesis, the same aspirations with which I joined and then ran Wellington, the same steadfastness that was required after I got fired, and the same energy, enthusiasm and zest for accomplishing the impossible with which I created and ran Vanguard.

Congress . . . a massive failure in the governance system.” But while Enron may prove to be the worst failure of our corporate stewards, I need not tell you it is hardly alone in its failure to merit the faith of investors. Casino Capitalism Lord Keynes warned us long ago of what happens when speculation achieves predominance over enterprise, and I also quoted some of these words in my ancient university thesis: “In one of the greatest investment markets in the world, namely, New York, the influence of speculation is enormous . . . it is rare for an American to ‘invest for income,’ and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that he is attaching his hopes to a favorable change in the conventional basis of valuation, i.e., that he is a speculator. But the position is serious when enterprise becomes a mere bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” The analogy of the casino to the recent era in our financial markets is hardly far-fetched. Investors have focused on short-term speculation based on the hope that the price of a stock will rise, rather than long-term investment based on the faith that value of a corporation will grow.

Blessed by being citizens, then, you must repay the bounty of that blessing. Boldly fulfill your obligations to yourself, to your family, to your community, and to your nation, and providence will move too. All sorts of things will occur that would never otherwise have occurred—a whole stream of unforeseen incidents of which you never have dreamed will come your way. Whatever you dream, begin it. Boldness has genius, power and magic in it. Begin it now. Well, not quite yet. First, reciprocate your family’s love, enjoy your college friendships, hold with pride your new diploma, and revel in your commencement day. But when tomorrow dawns, seize the day. Carpe diem. Summon your unique genius, your own power, and your personal magic. Just as it has done so unfailingly for me, providence will respond for you. It really will! In everything you do, be bold.

A half-century ago I discussed this issue in my senior thesis, noting Lord Keynes' concern about the implications for our society when "the conventional valuation of stocks is established (by) the mass psychology of a large number of ignorant individuals." The result, he suggested, "would lead to violent changes in prices, a trend intensified as even expert professionals, who, one might have supposed, would correct these vagaries, follow the mass psychology, and try to foresee changes in the public valuation." As a result, he described the stock market as, "a battle of wits to anticipate the basis of conventional values a few months hence rather than the prospective yield of an investment over a long term of years." But I had the temerity to disagree. In a far larger mutual fund industry, I suggested in my thesis, portfolio managers would "supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic, a demand that is based essentially on the (intrinsic) performance of a corporation rather than the public appraisal of the value of a share, that is, its price." Well, 50 years later, it is fair to say that the score is "Keynes one, Bogle zero." But it's not a moment too soon to measure up to my ideal for financial institutions: Moving from the folly of short-term speculation to the wisdom of long-term investment.

organization that spread the responsibility for success down through the company, division by division, unit by unit, person by person. I resisted—but only by a whisker—the temptation to personally review our list of givers, for I knew that some crewmembers who should participate wouldn’t, and some who could make major contributions would give pittances. But even without that pressure, we’ve done a pretty good job. We’ve become an important part of our community’s United Way effort. Vanguard’s total support—corporate plus crew, in roughly equal proportions—has grown has grown from $700,000 and 1,500 contributors in 1992, to $3.8 million and 9,500 contributors in the current campaign. We produced 1.5% of the greater Philadelphia campaign at the outset; this year our contribution exceeds 7%. Last year, we led our region’s total giving; our crew participation was 88%; and our leadership-giving counted 211 leaders, including 21 de Tocqueville Society members who gave $10,000 or more. How did we do it? The key to success is not a mystery. It’s the same key that opens the door to success in any campaign, indeed in any business. A combination of leadership, commitment, organization, execution, desire, and spirit. Making my own support clear, in both word and deed, was essential. Indeed, I was so committed that I violated my usual practice of doing my giving anonymously and made my United Way gifts and pledges public.

3% $ Cumulative percent of return consumed by costs 40% 54% 65% 71% 1 Applying the same methodology to bonds over a decade is even simpler. The current yield when the investment is made largely (90 percent correlation) determines the total return delivered by the bond. Thus, the current yield of about 2 ½ percent on a combined U.S. Treasury/corporate bond portfolio would represent the return—more or less—that we should expect for the coming decade. See Appendix I.

declines. Always remember--in good times and bad times alike--“this, too, shall pass away.” (I spent a full page on that sage piece of wisdom in my book.) Your emotions can kill you. You should keep them out of your investment program, for impulse is your foe. Fourth, rely on simplicity. There are too many witch doctors in this business . . . with too many patent medicines. Basic investing is simple--a sensible asset allocation to stocks, bonds, and reserves; a middle-of-the-road selection of diversified funds; a careful balancing of risks, returns and (lest we forget) costs, which can kill long-run returns. Don’t disregard low-cost index funds. (Warren Buffett just happens to agree on the importance of cost and the value of indexing--a nice “third person” endorsement.) And fifth, when you’ve followed these four rules--as I’ve said, and meant, a thousand times- -“stay the course” no matter what happens. Good luck in your investing during these interesting times. * * * Flash: A bright Vanguardian just provided me with the definition of “meme”: A contagious idea that replicates like a virus, passed on from mind to mind. Memes function the same way viruses do, propagating through communication networks and face-to-face contact between people . . . the basic unit of cultural evolution.

in 1928 and of Vanguard in 1974. That should have exhausted the diamonds in my Golconda, but there proved to be one more diamond awaiting my discovery here. I’ll come to that later. Before I do, I would like to talk a bit about leadership. While I have a rather large ego, I’m reluctant to personalize the forces that brought Vanguard to the very pinnacle of this industry, with a reputation (I’m immodest enough to say) that may well exceed even our frighteningly-large asset base. Starting a new firm, with a new name and a clean slate to write upon, I had but one ambition. It had nothing whatsoever to do with huge assets or dominant market share or anything that can be counted. I told this to the Directors at the outset; my goal was to make Vanguard the proudest name in the mutual fund industry. And I was absolutely determined to accomplish it. We would build the firm on just two ideas. One was simplicity. Our Funds would have clearly stated investment objectives, explicit investment policies, and precise performance measurement standards. Their portfolios would be broadly diversified, conservatively managed, and invested largely in high-quality securities. We would hold costs to the minimum, for, apparently almost alone at the outset, I had discovered the best-kept secret of the investment business: gross investment return, minus the cost of management, equals the net return earned by the investor.

You might as well enjoy that moderation in risk, for the stock market is a risky place. Even the value of the index fund fell 28% from the March 2000 high to the recent low. The $10,000 investment in the S&P Index had grown to $48,700 by March, 2000, only to tumble to $38,400 a year later. But consider, if you will, the risk of not being willing to assume market risk. $10,000 invested in a money market fund a decade ago would be worth but $15,500 today—a $5,500 profit that was less than one-fifth of the $28,400 appreciation in the index fund, even after the sharp market decline. These numbers reinforce the reputation of equities both as productive investments and as risky ones—a reminder that is both valuable and long overdue. Reasonable expectations suggest to me that we might see stock returns in the 6% to 10% range during the coming decade. If that seems too modest an expectation for common stocks based on past history, don’t forget that a possible 8% return on stocks would take each dollar to $2.16 by 2011, while a possible 4% future return on savings would take each dollar to $1.48, less than half the gain. Eschewing the risk of stocks, therefore, carries a risk of its own. Yes, “nothing ventured, nothing gained.” Pillar 5. Diversify, Diversify, Diversify. By owning a broadly diversified portfolio of stocks and bonds, specific security risk is eliminated. Only market risk remains.

0% 5% 10% 15% 20% 25% 30% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Financial Sector’s Share of S&P 500 Earnings, 1980 – 2007 2. Does this explosion create an opportunity for money managers? You better believe it does! Does it create a problem for investors? You better recognize that, too. For as long as our financial system delivers to our investors in the aggregate whatever returns our stock and bond markets are generous enough to deliver, but only after the costs of financial intermediation are deducted (i.e., forever), these enormous costs will seriously undermine the odds in favor of success for our citizens who are accumulating savings for retirement. Alas, the investor feeds at the bottom of the costly food chain of investing. The tremendous drain on investment returns represented by the costs of our investment system raises serious questions about the efficient functioning not only of that investment system, but of our entire society. Over the past two centuries, our nation has moved from being an agricultural economy, to a manufacturing economy, to a service economy, and now to what is predominantly a financial economy. But the financial economy, by definition, subtracts from the value created by our productive businesses.

that, over a lifetime of investing, only a relative handful of investors can succeed in doing so by any significant margin. If this is iconoclasm, so be it. Accepting this reality-that investors as a group will inevitably capture less than 100% of the rates of return provided in any asset class-is the first step in simplifying your investment decisions. Where should you begin? Consider that the ultimate in simplicity comes with the additional virtue of low cost. For the simplest of all approaches is to invest solely in a single balanced market index fund-just one fund. And it works. Such a fund offers a broadly diversified middle-of-the-road investment program for a typical conservative investor, allocating about 65% of assets to large growth and value stocks and 35% to high-grade bonds. Over the past 15 years, it would have captured 99% of the rate of return of the combined stock and bond markets. It doesn't get much better than that. Let me prove the point by comparing the cumulative returns of this industry's balanced mutual funds-a group whose portfolios tend to be quite homogeneous, composed as they are primarily of large stocks with both value and growth characteristics, and good quality bonds with intermediate-to-long maturities. This chart compares the returns of the average balanced fund with the no-load balanced index fund, using the S&P 500 Index with its annual return reduced by estimated costs of 0.2%.

From Taxes The impact of taxes on the capital component is another story altogether. The tax blessing, as it were, in the income component of return is overwhelmed by the tax bane on the far larger capital component. To take a simple example: during the past fifteen years, the average equity fund enjoyed an average annual return of 140/0- 2% from income and 12% from capital. On the income side, the tax bite (assuming 33%) would take 0.6%. But on the capital side, the net asset value of the average fund increased by just 6% per year, leaving 6% accounted for by realized capital gains. Again assuming a 33% tax rate on short term gains (taxable as income) and 25% on long-term gains-and that 20% of the gains were realized on a short-term basis-the tax rate would have averaged 27%, and the capital return reduced by 1.8 percentage points, sharply reducing realized (and publicly reported) returns to 11.6%, all the while leaving risk unchanged. Thus, three-fourths of the tax bite of2.4% is accounted for by realized capital gains. The fact is, then, that taxes have a hugely negative impact on relative returns. Playing off the title of an outstanding article by Robert H. Jeffrey and Robert D. Arnott in The Journal of Portfolio Management, "Is Your Alpha Big Enough To Cover Its Taxes?", I'd say: "No, your Alpha is being eaten alive by taxes."

The Tortoise and the Hare If we look at the relationship between the NYSE tortoise and the NASDAQ hare—it may be a trite analogy, but, by God, it’s perfect!—it is the tortoise that has won again, just as Aesop, with his ancient wisdom, described. And the tortoise wins if we start the comparison at the very beginning, with the inauguration of the NASDAQ Index at the start of 1972. Or if we start in 1982. Even if we start in 1992, when the idea of the New Economy was beginning to enter our consciousness, we have a statistical dead heat. And if we start the comparison just as the hare began his explosive dash in 1998—a dash that took him so far ahead of the tortoise that he was almost out of sight—his equally mad reverse dash took him back to the plodding tortoise and then behind, and he even lost that lap of the race too. And so it is that the best of times for the NASDAQ were too good to be true, and that the worst of times has restored us to some semblance of market reality. Mkt Cap of 9 Tech Stocks Mkt Cap/GDP P/E Ratio 107% 180% 124% $191 B $1,600 B $570 B 12/97 3/00 3/01 Metrics of The Stock Market Bubble The Tortoise and the Hare Start Date NYSE Nasdaq NYSE Advantage 1/1972 1/1982 1/1992 1/1998 Annual Returns Through 3/01 12.6% 11.1% +1.8% 15.4% 13.5% +2.2% 13.4% 14.3% -0.3% 6.6% 6.0% +2.1%

18% for stocks, but perhaps 4% to 8%. Not 10% for bonds, but perhaps 5% to 7%. Not 7% for the money markets, but perhaps 3% or 4%. Maybe we’ll be surprised on the upside. I hope so! Taking the Toll 1: Fund Costs But whatever the returns in those markets turn out to be, the returns of comparable mutual funds will be significantly lower. The reason for the lag, of course, is costs. And we know pretty much what those costs are: management fees, operating expenses, sales charges, portfolio turnover costs, out-of-pocket fees, and cash drag. (Most stock and bond funds hold a small percentage of their assets in cash.) All-in costs for the average stock fund come to something like 2½% per year; for the average bond fund, 1 1/3%; for the average money market fund, 7/10 of 1%. In the new era I foresee (I hope I’m wrong!), equity fund costs would consume between 30% and 60% of stock market returns. Bond fund costs would consume from 20% to 25% of bond market returns. And money fund costs would consume about 25% of money market returns. Taking The Toll 2: Market Timing Further, while the average equity fund provided returns of 15% during the great bull market, please don’t make the mistake of thinking that the average equity fund investor earned 15%. No, recent data suggest that such an investor earned about 6%. Just 6%! Less than regularly rolling over a bank three-year certificate of deposit during the two decades. How can that possibly be? The answers are not very complicated.

Sharply reduced costs in this fund industry will obviously serve fund shareholders, but it should not go without saying that it will also serve personal financial advisers. You charge, as you must, fees for the services you provide your clients, and you deserve a wide choice of suitable, fairly-priced funds from which to choose the mutual funds you offer. That simple fact, indeed, lies behind my conviction, reached more than a decade ago, that Vanguard, with its low- costs, should be the natural ally of financial planners and registered investment advisers, with their need to keep the total level of client costs at reasonable levels. Working in unison, personal financial advisers can press the funds to reduce their costs with a power far greater than my idealistic vision. If your association, representing individual investors, could somehow join with retirement plan trustees, representing institutional investors, and demand a fair shake for fund investors, you could make a real difference in enhancing the future returns earned by your clients. In this context, I was struck by your Code of Ethics. It uses wonderful words that, as it happens, rarely if ever appear in mutual fund literature: “fiduciary responsibility to clients. . . practicing fairness and suitability. . . integrity and honesty.” These are the right words to describe the values of firms and individuals entrusted with the stewardship of the assets of investors.

. . for success itself, not for the fruits of success”—are in the ordinary course of events succeeded by businessmen who are more susceptible to temptation by the fruits of success and the greater personal wealth that results from building their empires. They perceive, perhaps correctly, that having public stock available to acquire other enterprises will enhance—for better or worse—their ability to achieve those goals. Yet one of the secrets of success is remembering whence you came, living up to the character you have established, placing the trusteeship of the assets entrusted to you by your owner-clients first, even if it entails substantial personal cost. I salute the Contributionship for staying the course that has served its policyholders so well, even as I assure you that I have neither personal nor professional regrets about creating a mutual structure for Vanguard. While mutuality is hardly in vogue today, it has been the linchpin of the strategy of two firms that have dared to march to a different drummer. They have succeeded in their highly competitive business simply by being companies that stand for something. II. Invention It is impossible to imagine a contemporary American who has demonstrated anything remotely resembling the breadth of interests of Benjamin Franklin. He was a central participant in the drafting of both the Declaration of Independence and the Constitution, and a signer of both.

intuitively, could not possibly enhance fund returns relative to the market, it is high time that fund costs be reduced. That vast $1.1 million chasm in the amount of capital accumulated— occasioned primarily by investment costs—reminds us that we need to use technology to help us get there. (2) Better Investment Products? Thanks in part to technology, the fund industry certainly has a lot more products—8,341 funds today, compared to 564 funds in 1980. The incredible power of the computer has not only enabled the development of innovative and complex financial market instruments, but the creation of new kinds of mutual funds—“new products,” as the industry refers to them. Technology enables us to backtest with remarkable facility the results of any kind of fund; a fund that invests on the basis of a stock’s price momentum, for example, or a fund that invests in companies sending positive signals to Wall Street by beating the earnings estimates with which it has conditioned the marketplace. Alas, however, backtesting proves to have little predictive power. Technology has also facilitated the development of so-called quantitative funds, relentlessly using modern portfolio theory to search the market for winning stocks through computer models that calculate risk factors, size factors, industry factors, financial structure factors and the like. The result: A diversified portfolio that, if all works well, will consistently outpace the market.

between the hedgehog and the fox. “The fox knows many things,” Archilochus told us 2200 years ago, “but the hedgehog knows one great thing.” In an industry filled with brilliant, sly, ambitious, impatient, high-cost investment manager-foxes, trading portfolio securities with a vengeance and ever seeking the holy grail represented by outpacing the financial markets, we are the principal hedgehog. We know the one great thing: that the closest we will get to that holy grail will come by owning a widely-diversified portfolio of high-quality stocks (or bonds) that effectively represents the market, trading those securities only when absolutely necessary, and operating at low-cost. Our best-known strategy, of course, is stock market indexing. We now manage 28 index funds (including four bond index funds and six balanced index funds), but more than 75% of our $210 billion in index fund assets is represented by two funds modeled on the S&P 500 Index, and one modeled on the Wilshire 5000 Total Stock Market Index. We pioneered the first index mutual fund in 1975; our level of conviction reflected in the fact that, following our commencing operations in May of that year, it was Vanguard’s very first business decision. As it has turned out, indexing was a transforming decision for the firm, the apotheosis of all we stand for in linking cost and value—low cost and high value, inextricably intertwined.

Second, the S&P 500 has actually turned in a slightly higher annual return than the stock market over the full 75-year period: 11.0% vs. 10.6%, suggesting that small-cap and mid-cap stocks as a group have produced an annual return of about 9.6% per year. Of course there were—surprise!—frequent reversions to the mean during the period, with large caps doing much better during the depression years than from the end of World War II through 1955, and then during the great bull market that ran from mid-1982 to March 2000. But the fact is that the S&P 500 index that we selected in 1975 as the benchmark for the Vanguard 500 Index has stood the test of time. I have no doubt that will do so long into the future.

stocks in the corridors of commerce and at cocktail parties alike. For millions of investors, funds are stocks, and when particular funds are hot, that’s where the investors’ capital flows . . . and, of course, vice versa. What is more, yesterday’s investment industry has become today’s marketing industry. Once we sold what we made; today we make what will sell. Hot performance. Mutual funds using sophisticated investment techniques are aggressive beyond anything we might have imagined 15 years ago. Internet funds; micro-cap funds; and quantitatively managed funds. Funds based on theories of price momentum, earnings expectations, technical readings of the market, and multiple regressions that, dare I say, boggle the mind. Even funds for stocks in Vietnam and Indonesia and the Czech Republic—none hitherto known as bastions of capitalism. Further, even old-line funds follow strategies that only yesterday would have been deemed outrageous. On average, mutual fund managers turned over their portfolios at a 15 percent rate in the 1950s and 1960s. Even in the "Go-Go Years” of 1965-68, the rate rose to “only” 40 percent. But last year, the turnover rate was 90 percent, suggesting that the average holding period for a given stock is now just 406 days.

It will require more of our national treasure, and business must do its share, committing its energy, its people, and its capital. It is a wise investment, for given the linkage between education, employment, drugs, and crime, the long-run cost of not investing—the cost in lost productivity and in dealing with social upheaval—will far exceed the cost of the commitment to public education our nation clearly requires. But let me remind you that we can’t leave all the problems to others. “We the people” includes “we.” Everything in life begins with an individual action, and I will go to my reward unshaken in my belief that even one person can make a difference. We can begin by supporting the splendid independent education that is so close to us—here at Shipley and, if I may, at Blair Academy as well—not only the best that money can buy, but, even more, an education that communicates and reinforces a sense of moral commitment, social virtue, and community responsibility—a compassionate participation in the world. It is these ideals that will truly enable America to live up to her heritage and remain the light of the world. We must all do our part, not the least of which is striving to develop in our youth the great values of America. Today America cries out for enlightened moral leadership at all levels, from the Presidency on down. Today, we have considerable room for improvement.

Schumpeter’s Three Entrepreneurial Standards As I hope you can sense, laying this solid foundation was an exciting business, replete with a sense of purpose, success and failure, elation and disappointment, close calls, a bit of foresight, and no small amount of luck. Looking at this history, our Yale senior sought to reach his conclusion. If I were to be deemed an entrepreneur, I would have to fulfill the three tests of entrepreneurial drive set forth by Schumpeter: first, the dream and the will to found a kingdom; second, the will to conquer and the impulse to fight; and third the joy of creating and exercising one’s ingenuity. Here’s what the Yale paper found: “First, the dream and the will to found a kingdom . . .” Here, the paper, using Schumpeter’s words, generously dates my dream as first arising in my Princeton thesis. He notes, correctly to be sure, that “the dream was in and of itself not remarkable, . . . particularly for a young idealist. What was remarkable was that he had the determination to stick with it until he had created . . . . a new sort of investment company, ‘of, by, and for the investors’—not the investment managers.” And he is right. That is just what Vanguard is today.

seems a specious, even self-serving, reason for allowing those at the top of the business pyramid to have complete protection from challenge and possible removal from office. The entrenched business interests also allege that even limited access to the slate would open the door to “special interest” directors, less-well qualified directors, and dysfunctional boards. But these developments could only occur with the consent of the owners, and there is no reason to assume that a majority of owners would vote for unqualified or irresponsible directors. While a board constantly engaged in civil war would hardly serve the owners’ interests, however, it is not at all clear that those interests aren’t equally ill-served when harmony is so embedded that no dissent can be brooked. Surely we can all think of individual cases in which shareholders have paid a high price for collegiality so deep-seated that it stifles dissent. What is more, all directors, no matter how nominated, have a fiduciary duty to act solely in the interests of the shareholders of the corporation. It’s up to the owners, not the managers, to weigh the pros and cons of the issues surrounding electoral challenges and board composition and, by exercising their franchise, decide them. It’s called corporate democracy. Beyond the Board Slate The second issue regarding shareholder access to the corporate ballot is the ability of owners to make proposals regarding corporate activities.

It would seem clear, to take an extreme example, that if equities were to carry a risk premium of 2.5% over long-term U.S. Treasury bonds, the choice between an equity fund with an expense ratio of 2.5% and a Treasury bond would be indifferent: Theory would say that the long-term returns of the two investments over time would be identical. Cost would have consumed 100% of the equity premium. Viewed in this light, all of the costs of investing—advisory fees, other fund expenses, and transaction costs—bite into the risk premium. The difference is simply a matter of degree, although at the highest cost levels it is arguably a difference in kind. This table shows the percentage of the risk premium consumed by mutual fund expenses at various premium levels (for the purpose of simplicity, transaction costs, which could add another 0.1% to 1.ignored):

I hoped my own commitment would inspire my colleagues at Vanguard and my counterparts in other firms to step up to the plate, too. Only time will tell whether or not I succeeded. Creative Destruction Now in fairness, most of this growth in our United Way program is a reflection of our growth. Our fund assets of $550 billion this year have multiplied six-fold since 1992. That growth has been a happy, even essential, event for our community. For in the financial services industry during this period we’ve seen much creative destruction—the phrase Joseph Schumpeter coined to describe the impact of innovation and entrepreneurship in our economy. The names of most of America’s largest regional banking institutions have vanished, their once-local identity subsumed by national pachyderms, as across the nation the banking industry has relinquished to the mutual fund industry its traditional role as the savings vehicle of choice for America’s families.measurably

While gross stock market returns are interesting, such data are tragically flawed. Nonetheless, these data are the Lingua Franca, in their naiveté, of market statisticians, economists, journalists, and pension fund advisers. But they fail because they ignore the self- evident fact that we investors, as a group, do not, cannot, and will not capture 100 percent of the stock market’s returns. As we saw in Chart 2, those seemingly modest annual fees can consume the overwhelming majority of our investment return over the long-term. Simply looking at market return data ignores the many costs of investing—fees paid to advisors, the costs of trading stocks, all those marketing costs, and the administrative, accounting, and legal costs imbedded in our financial system. No matter what the return on stocks, it is the croupiers of Wall Street who are enriched as investors feverishly swap stocks with one another in an inevitably costly and fruitless game that we investors as a group are destined to lose. Think about it this, perhaps cynical, way: the mutual fund industry can be said to be the only industry in the world in which, collectively, we investors are guaranteed not to get what we pay for. Indeed, we get only what we don’t pay for. So the less we pay to earn the market’s return, the more of the return we in fact get. Conclusion: if we pay nothing, we get everything.

Sure, few (if any) of us have a century of life in us (yet!), but, like the Gotrocks family over the generations, the miracle of compounding returns is little short of amazing—the ultimate winner’s game. The problem is that this miracle of compounding returns is overwhelmed by the tyranny of compounding costs. If we assume even 2 percent in annual costs, that 9.5 percent nominal return drops to 7.5 percent, and the accumulated capital drops to just $2,100—less than one-seventh as much. In our foolish focus on the short-term stock market distractions of the moment, we, too, often overlook this long history. We ignore that when the returns on stocks depart materially from the long-term norm, it is rarely because of the economics of investing—the earnings growth and dividend yields of our corporations. Rather, the reason that annual stock returns are so volatile is largely because of the emotions of investing. Put another way, while illusion (the momentary prices we pay for stocks) often loses touch with reality (the intrinsic values of our corporations), in the long run it is reality that rules.

I freely concede that, given the way the fund industry has traditionally been structured and the way fund boards have traditionally operated, acting with independence is no mean task. Directors are typically invited on the board by the chairman, and the chairman and other officers of the manager control the board agenda. The prevailing perception is that the system works just fine, and “rocking the boat” is rarely a valued attribute. Most independent directors, I’m confident, do their best to be fair, but the pervasive nature of the board’s domination by the manager, when added to the director’s self-interest in receiving fees (which obviously grows stronger as fees rise), makes it easy for even the best of directors to justify a collegial acceptance of the status quo. Avenues for Change How can we endow fund directors with true independence?help:

Part of the problem is that these giant institutions, striving to build their own profitability, turned their focus away from management and toward marketing, toward whatever will sell, explaining ever-more-narrowly-focused, riskier portfolios. Let’s call that the triumph of salesmanship over stewardship. These agents—now largely controlled by giant U.S. and international financial conglomerates—have too often put their own interests ahead of the interests of those whom they are duty-bound to serve, those 100-million-plus fund shareholders and pension beneficiaries who inevitably feed at the bottom of the food chain of investing. What’s more, I would argue that our now-dominant institutional agents have not only failed to honor the interest of their shareholders/beneficiary principals, but they have also abandoned the time-honored investment principles that focused on the wisdom of prudent long- term investment, and turned instead to an excessive focus on short-term speculation, so clearly demonstrated by the soaring portfolio turnover that I described earlier, a change that is detrimental to their own interests as well as to our financial system.

percentage points less, a shortfall that closely parallels our three percentage point estimate for fund costs.1 In other words, the funds earned about 80% of the market’s annual return. But when we compound the annual returns based on an investment of $10,000 at the start of the period, the investor captured only 60% of the market’s cumulative wealth. The market investment would have grown by $120,000, compared to just $71,600 for the average fund. The magic of compounding investment returns; the tyranny of compounding investment costs. What is more, it’s no secret that the fund industry, once an industry that prized investment stewardship as its highest value, has now embraced product marketing as its beacon. In their battle to build assets, and thus advisory fees, mutual fund sponsors are quick to capitalize on the latest fads and fashions of the stock market. During the great NASDAQ bubble, for example, fund sponsors created record numbers of new growth and aggressive growth funds with a heavy tech-stock orientation (340 funds) and pure tech funds (116), with pace-setting budgets advertising their pace-setting short-term returns. These funds rose by an average of 85% during the final upsurge in the market from 1999 through March 2000, and those that were advertised had even higher returns. The result: Great for the marketers, horrendous for the investors. These aggressive funds were the recipients of the largest glut of cash inflow in the industry’s history—$238 billion.

Yes, as some naive defenders of the present ethos argue, some 40% of equity fund assets are held in tax-deferred accounts, so taxes don’t matter. But there is no evidence whatsoever that all of this flailing around enhances returns. Thus, the high turnover that is radically diminishing the returns of 60% of fund shareholders does nothing that benefits the remaining 40%. The shift from long-term investing to short-term speculation, then, is hurting the very shareholders that fund directors are duly-bound to serve. Myth #3. Mutual Fund Shareholders are Long-Term Owners Like the “ILOVEYOU” virus, the virus that has so adversely infected the duration of the lives of mutual funds and the duration of the horizons of fund portfolio managers seems to be wildly contagious. Mutual fund shareholders are now suffering from the same malady—a game of “follow the leader” that is, I am confident, utterly unproductive. When I wrote my thesis, and for twenty years thereafter, share redemptions by fund shareholders averaged about 7% per year, suggesting an average holding period of slightly over 14 years. (The reciprocal of the redemption rate is a crude, but reasonably accurate, indicator of the holding period.) This figure gradually drifted upward to the 15% range by the mid-1980s, a seven-year holding period.

But our greatest Presidents have illuminated our values, strengthened our determination, and reinforced our national character. The spirit of spirited Americans—Abraham Lincoln, Woodrow Wilson, Theodore Roosevelt, Thomas Jefferson, Thomas Paine—must continue to set our standard. Back to Basics While the world has changed radically in 1000 years, however, what we as parents and grandparents want from our time on this earth has changed very little. Even as we want our posterity—our children and our children’s children—to have healthy, productive, fulfilling lives as good citizens of a great nation, so too did a parent-poet-philosopher whose ancient words are quoted at the end of The Year 1000. Entitled “The Fortunes of Men,”2 his poem—a meditation on fate—first dealt with the beginning of life: 2 I know you understand that “man” was the accepted formulation of the day, and meant “humankind.”

The Total Stock Market Index Nonetheless, I continue to favor the Wilshire Total U.S. Stock Market Index as the prime benchmark for an index strategy—not to the exclusion of the S&P 500, but as the place to begin for most investors who are not yet indexing. While returns of the two indexes are apt to be identical over the long-run, there seems little to be gained by accepting any short-run deviation from the market. At Vanguard, we began to implement the total market strategy in 1987 with the creation of the industry’s first Extended Market Index Fund, (based on the Wilshire 4500 Index), enabling investors to fill out their S&P 500 portfolios by adding the rest of the market. But, convinced that this two-pronged strategy might someday result in surprisingly high portfolio turnover as stocks moved back and forth between the indexes, in 1992 we introduced the first total stock market index fund, based on the Wilshire 5000 Index. I believe that it is only a matter of time until the total stock market, most easily measured by the Wilshire 5000, becomes the basic standard for the broad-based indexing strategy. The Wisdom of Stock Indexing After more than a quarter of a century of stock indexing, how has it worked? Unbelievably well! Consider the results of Vanguard’s 500 Index Fund since its initial underwriting in 1976. First, it survived, something that can’t be said about 160 of the 356 equity funds in existence when we made our debut.

The biggest of these in the past few years, in terms of number of news stories tracked by RepRisk, has been whether its talcum powder causes cancer and whether the company knew this. (The other lawsuits J&J has faced are around criticism it has received for its role in selling opioid painkillers and the safety of its mesh products). The Baby Powder talc lawsuits started in 2016, when J&J was ordered to pay $72m in damages by a court in Missouri to the family of Jacqueline Fox, a 62 year-old woman, who died from ovarian cancer in 2015. She had used the product for decades on her genitals and her family argued that J&J knew of the risks and failed to warn users. This was the first time damages were awarded by a US jury over talc claims. J&J appealed the verdict, which they later won, but it set a precedent for others to follow suit to claim damages against J&J for their ovarian cancer. The result of this trial would appear to show that J&J was responsible for miss-selling and irresponsibly sold a product that they knew contained asbestos and would cause the death of patients.41%

Alas, the slips ‘twixt cup and lip seem as eternal ever, and there’s no evidence that any of these new types of funds have provided better returns than their traditionally managed kinfolk. But for very different reasons, the New Era of technology has given fund owners not only worse returns, but much worse returns. The boom in technology stocks during the late 1990s resulted in the creation of 678(!) risky new funds—Internet funds, telecom funds, technology funds, and technology-oriented growth funds—largely designed to attract fund investors eager to participate in the great NASDAQ boom. The industry’s resultant hyping and promotion of these “New Economy” funds rapidly increased the industry’s risk profile, which reached its most dangerous exposure in mid-March 2000, at the very moment that the bubble, having reached its point of maximum inflation, was about to pop.

Such speculation not only flies in the face of intelligent investment policy, it carries heavy transaction costs and unnecessary tax costs that frustrate the objective of fund shareholders to earn returns that even approach the returns of earned in the stock market. What ever happened to long-term investing by professional managers? By anyone? In short, mutual fund managers—once considered as long-term investors—have become, to an important degree, short-term speculators. Many of the former shepherds of the flock have become the sheep of the pasture: a roaming, inconsistent, wild lot, given to impulsive—if sometimes precisely quantified—decisions that frustrate the very purpose of investing on the basis of traditional standards of corporate valuation. We have investment technology to thank for its role in helping us to engage in all of this feverish activity. But technology has given us the tools without giving us the wisdom to handle them constructively.Information

Our defined-asset class fixed-income strategy, while far less renowned, has been equally effective for investors. Our bond and money market funds now constitute $140 billion of our assets. Just as our indexing strategy reflects, finally, a skepticism that any firm, including ours, can discover the holy grail of outpacing the stock market—and then hang onto it for decades, which is every bit as important— so our bond strategy strongly manifests a similar skepticism about the ability of any firm, including ours, to consistently and accurately forecast changes in interest rates. As a result, when we joined the wave of firms offering new municipal bond funds in 1977, we followed, not the conventional path of forming a “managed” municipal bond fund, but created, for the first time in mutual fund history, a three-tier bond fund—a long-term series, a short-term series, and (this will hardly surprise you!) an intermediate-term series. We would win by approximating the pre-cost returns of the benchmarks of each sector of the bond market, then keeping our costs at the industry nadir and maintaining quality at the industry pinnacle. Result: The delivery of outstanding bond returns to our shareholders. If this simple strategy hardly sounds to you like genius at work, you are very perceptive! No more genius, indeed, than the basic mathematics of indexing: Earning the market’s return at low cost trumps earning the market’s return at high cost.“the

He not only established a fire company and an insurance company, but a library, an academy and college, a hospital, and a learned society, all the while running a successful printing business at which he made his living. Like many entrepreneurs, Franklin was also an inventor, creating among other devices the lightning rod and the Franklin stove. He made no attempt to patent the lightning rod for his own profit, and declined the offer by the Governor of the Commonwealth for a patent on his Franklin stove. That “Pennsylvania fireplace” that he invented in 1744 to economize on fuel and improve the efficiency of home heating was designed to benefit the public at large. For Franklin believed that, “knowledge was not the personal property of its discoverer, but the common property of all. As we enjoy great advantages from the inventions of others,” he wrote, “we should be glad of an opportunity to serve others by any invention of ours, and this we should do freely and generously.”

If you can influence this industry not only to promulgate the same standards, but to reduce costs, perhaps my words today will mark the beginning of constructive change in the mutual fund industry that will advance the interests of tens of millions of its shareholder-owners. Four Generations—Two Authors—One Idea It will take a long time. I know that, if only because of the experience of Great Grandpa Armstrong, an insider taking on the property insurance industry in the 1880’s and 1890’s. According to his biography, “his methods were original and diametrically opposed to almost every recognized underwriter in the country.” Perhaps frustrated by the failure of his ideas to catch hold in the fire insurance industry, by the turn of the century he had turned his critical gaze to the life insurance industry. He wrote a classic, if rather intemperate, book entitled, “A License to Steal,” subtitled “Life Insurance, The Swindle of Swindles. How Our Laws Rob Our Own People of Billions,” published in 1917.these:

One reason for that remarkable shortfall is that fund investors, to an appreciable degree, were engaging in a sort of “market timing” exercise. With the Dow Jones Industrial Average below 1300 from 1982 to 1984, for example, American savers placed just 2% of their annual savings in equity funds. Even during the early 1990s, with the Dow below 4000, the equity fund flow represented only 20% of savings. But during the twelve months ended March 31, 2000, with the Dow often over 11,000, investors invested an incredible 120% of their savings into equity funds. And, when the inevitable bear market came, investors virtually ceased their equity fund purchases. During 2001, cash flow into equity funds plummeted to just 11% of savings for the year. Sitting on the sidelines when stocks are low and plunging into the market when stocks are high, clearly, is not a formula for investment success.

Cash Flows – The Investment Essential To explain what happened, we can again rely on Dickens’ words, for we have returned from the epoch of incredulity to the epoch of belief. As I stressed in my year-ago speech, despite the dichotomy that appeared to exist between two U.S. economies—the Old Economy of Industrial America and the New Economy of the Information Age (a difference that is quite nicely captured, as it happens, between the stocks listed on the NYSE and those traded on the NASDAQ over-the-counter market), the mathematics of the market ultimately come down to the theory that is universally taught in undergraduate finance classes and graduate business schools: In the long-run, the rewards of investing must be based on future cash flows. For the purpose of the stock market, simply put, is to provide liquidity for stocks in return for the promise of future cash flows, enabling investors to immediately realize the present value of a future stream of income. If investors didn’t simply ignore this inevitable truth, they anticipated future streams of income that lost touch with reality, projecting that the earnings of the New Economy stocks would grow at unprecedented rates in order to justify price-to-earnings ratios that ranged from 50 times earnings, to 150 times, all the way to infinity. (Infinity is reached when there are no earnings, so the price-to-sales ratio is substituted, often itself reaching hundreds of times.)

Here are the results, based on an initial investment of $10,000 in 1983. Three key conclusions: 1. The managed funds provided an annual return of 13.0%, the Index Fund 15.1%--85% of the market's return for the managers, 99% for, if you will, the non-managers. 2. After 15 years, the investment in the managed fund was worth $62,700, the index fund $81,900 (wow!) The managed balanced fund provided 71% of the market's cumulative return, versus 97% for the index fund. Time and compounding have joined forces to turn a 2.1 point annual advantage into an advantage of $19,000 in accumulated wealth-twice the initial stake! "Little things mean a lot." 3. The superiority of the index fund is accounted for, not by magic, but by costs. The heavy costs of the managed funds were primarily responsible for their shortfall.

220 basis point cost have taken on the 13.3% return earned on the Standard & Poor’s 500 Stock Index over the past 50 years? The fund would earn 11.1%, or 2.2% less. When compounded, $1,000 in the S&P Index itself would grow to $514,000; the fund, after costs, would grow to $193,000—a $321,000 loss to the financial intermediaries. When we include taxes in the equation—given the high market returns of the past 50 years, I’ll use 240 basis points, a conservative tax rate—the mutual fund annual pre-tax return of 11.1% drops to 8.7% after taxes, and the compounded value falls another $128,000 to $65,000. But there’s more trouble ahead. Each year, intermediation costs and taxes are paid in current dollars, while the investor’s final capital must be measured in constant dollars. During the past half-century, the inflation rate was 4.0%. Result: Real annual return for the investor, 4.7%. The final purchasing power was reduced another $55,000 to $10,000. Wow! Put another way, the mutual fund’s real annual return before costs was not the 13.3% earned by the S&P Index, but 9.3%, so the 2.2% intermediation cost reduced each year’s real return, not by 16%, but by 24%. And that 2.4% annual tax cost further reduced the fund’s net return, not by 22%, but by 34%.

Think about it: while the owners of business enjoy the dividend yields and earnings growth that our capitalistic system creates, those who play in the financial markets capture those investment gains only after the costs of financial intermediation are deducted. Thus, while investing in American business is a winner’s game, beating the stock market before those costs—for all of us as a group—is a zero-sum game. And after intermediation costs are deducted, beating the market becomes a loser’s game. The rise of the financial sector is one of the little-told tales of the recent era.giant

Morgan’s Wellington Fund—and my career in the financial markets began. It would be, well, fatuous to think that I’ve left our nation’s markets in better shape than when I first found them way back in 1949. It would also be wrong. For institutional investing has moved from an earlier era focused on the professional standards of trusteeship to a new era of asset gathering and salesmanship, from management to marketing, from the wisdom of long-term investing to the folly of short- term speculation, and from being owners of stocks to renters. (Turnover of shares in the stock market was about 25 percent in the 1950s and 1960s; today it is 150 percent—six times as high.) These changes have ill-served investors. So in my speeches across the land, and especially in my most recent two books (The Battle for the Soul of Capitalism, and The Little Book of Common Sense Investing), I’m shamelessly campaigning to return capitalism and the financial markets to the values that made them such priceless national assets in an earlier age. Only if we return our economic system to its proud roots, and focus on long-term investing rather than short-term speculation will the job of capitalism be well done. Emboldened by the fine reviews of The Little Book in Sunday’s New York Times, in Monday’s USA Today, and in today’s Wall Street Journal, I’m encouraged that the message is finally beginning to gain traction.

With this remarkable insight, we could say (though we didn’t dare to say it for quite a few years) that the central task of investing is to realize the highest possible portion of the returns earned in the financial markets by the asset class in which you invest—stock, bond, money market alike—recognizing and accepting that (and here is the key phrase) that portion will be less than 100%. The recognition of this reality finds its apotheosis in our low-cost index fund, which provides 99% of the market return. For the record, the portion provided by the average mutual fund—stock, bond, and money market—has been about 85%. With the fundamental Vanguard diamonds—our mutual structure and our focus on low-costs—we have had the best possible opportunity to approach that 100% desideratum. The second idea may surprise you. It was to make human beings the focus of our firm.and

This risk is reflected in the volatility of your portfolio and should take care of itself over time as returns are compounded. 3. Time Marches On $0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Avg. Eq. Fund S&P 500 Fund Money Mkt. 4. Nothing Ventured, Nothing Gained $15,500 $31,900 $38,400 Note: Return required on S&P 500 to reach $108,000 in 2016 is 7.March)

Wall Street’s conflicted sell-side analysts have lost their objectivity; the buy-side analysts of our large financial institutions have put aside their skepticism; too many of our corporations have forced the fulfillment of their aggressive earnings guidance by fair means or foul; off-balance-sheet special purpose enterprises have been created largely to conceal debt; and illusory transactions have raised reported growth in sales. And that’s hardly the end of the list: Enormous compensation from stock options has enriched corporate executives who have succeeded in hyping the price of their stocks without increasing the value of their corporations; auditors have had important business incentives to be partners of management rather than independent professional evaluators of management’s financial reporting; and millions of employees have lost faith in their retirement plan investments. As these forces came together, investors came to realize that they had assumed risks that were far larger than those for which they bargained. They are demanding a higher risk premium, which in turn has raised the cost of capital. Unless we resolve these nettlesome issues in favor of the stockholder, that higher cost will ultimately drag down our economy.

Through some combination of scientific miracles, my medical guardian angels, my faith, and the Lord, my second chance at life has miraculously granted me the marvelous luxury of this third career. Indeed as I count my blessings of family and friends, and reflect upon how infinitely lucky I have been in my career, it gives me a bit of a tingle. Of course there is so much to be done, and so little time. But the words that Tennyson attributed to Ulysses as he returned from his long odyssey inspire me to press on: Come, my friends, ‘tis not too late to seek a newer world. Push off, and sitting well in order smite The sounding furrows; for my purpose holds To sail beyond the sunset til I die. Tho’ much is taken, much abides; and tho We are not now that strength which in old days Moved earth and heaven, that which we are, we are— One equal temper of heroic hearts, Made weak by time and fate, but strong in will To strive, to seek, to find, and not to yield. Thank you again for this signal honor.

Most funds continue to buy and then sell securities unremittingly, and then sell them and buy them over and over again. Believe it or not, fund portfolio turnover has risen to an all-time high of 112% this year, meaning that the average fund held onto a stock for just 326 days. That holding period is far more akin to short-term speculation than to long term investing, which, not so many years ago, is what this industry was all about. The rake wielded by the brokers, investment bankers, and institutional traders is also a wide one. To pay for this staggering transaction activity, turnover typically rakes off 0.5% to 1.0% of fund assets each year. Consider a $1 billion stock fund with 112% turnover: It sells $1.12 billion of stocks in a year, and reinvests the $1.12 billion proceeds in other stocks, total transactions of $2.24 billion, even higher if the fund draws cash inflow from investors. This high turnover is in part the product of trading by hyperactive portfolio managers, anxious to garner a performance edge on their peers, however fruitless the quest. But there is also turnover among the managers themselves. All too often when a manager departs, the new manager’s broom sweeps clean, as he reorders the portfolio to comport with his own strategies. Believe it or not, the average mutual fund manager lasts just five years. For one giant firm, the average tenure is but 2 ½ years, as the croupiers come and go.prospectus),

Virtually that entire margin was then lost during the next five years, leaving small caps about at par with large caps for nearly the full half-century. The small cap reputation was made during the 1973-1983 decade. Then, seemingly inevitably, RTM struck again for the fifth cycle. Just as the proverb warns us, it was darkest for the large caps before the dawn, and since then the sun has shone brightly upon them. On balance for the full period, the compound annual return on small cap stocks was +12.7% compared with +11.0% for large cap stocks. This difference, to be sure, resulted in a terminal value for small cap stocks that was three times that of large cap stocks. But, given the dominance of small caps in this single decade, I’m not sure I’d rely on it.stock

An orchestra and chorus from Haverford and Bryn Mawr Colleges—bright-eyed young souls just like so many of you— reminded me that the poem had been written from the perspective of an idealistic, aging warrior—“one man with a dream, at pleasure, shall go forth and conquer a crown.” Well, despite my dream, the crown hasn’t been conquered—yet. But heed today the challenge of this warrior who speaks to you now, invigorated, enthusiastic, and energetic after miraculously being granted a second chance at life. And respond, if you will, to this challenge from my generation, using our poet’s final stanza: Great Hail!yore;

And as Mr. Buffett has observed: “negotiating with oneself seldom produces a barroom brawl.” Just as owners capitalism has turned to managers capitalism in corporate America, so has owners capitalism turned to managers capitalism in mutual fund America. Despite the clear language of the Investment Company Act stating that funds must be organized, operated, and managed in the interests of their shareholders rather than the interests of their investment advisers, mutual funds are in fact operated in the interests of their managers. But it wasn’t always that way. True owners capitalism has never been possible in this industry, whose millions of owners are largely individual investors of relatively modest means.industry’s

Fixing our business and financial system must begin with a return to the original values of capitalism, to that virtuous circle of integrity—“trusting and being trusted”—as I mentioned at the outset. When ethical values go out the window and service to those whom we are duty-bound to serve is superseded by service to self, the whole idea of the capitalism that has been a moving force in the creation of our society’s abundance is soured. In the era that lies ahead, the trusted businessman, the prudent fiduciary, and the honest steward must again be the paradigms of our great American enterprises. It won’t be easy, but if we all work long enough and hard enough at the task, we can build, out of a long-gone ownership society and a failed agency society a “fiduciary society,” one in which the citizen-investors of America will at last receive the fair shake they have always deserved from our corporations, our investment system, and our mutual fund industry.

I also strongly favor the use of indexes from market segments as the standards for funds with particular investment styles (i.e., large-cap value, small-cap growth, etc.) However managers should be warned that, taking into account relative return (generally solid for the segment indexes across the board) as well as relative risk (generally significantly lower for the indexes, a point almost universally ignored), the advantages of an index strategy are equally apparent at all market cap levels and in all investment styles and venues. So, market segment index funds seem certain to take their proper place in the marketplace, and all forms of indexing—now about 15% of institutionally-managed equity assets, will continue to grow, perhaps to as much as 25% to 30% a decade hence.

Largely focused on management when I wrote my Princeton thesis about the industry, our predominant focus today is on marketing—increasing fee revenues by building up assets under management, often by creating, promoting, and advertising speculative funds that follow the fads and fashions of the day. As you will soon learn, our fund investors have paid a terrible price.  Two, the conglomerates take over. When I entered this field all those years ago, virtually 100 percent of mutual fund management companies were privately-held firms, relatively small, and managed by investment professionals. Since then, they have experienced their own pathological mutation. Today, 41 of the 50 largest fund management companies are publicly-held, including 35 that are owned by giant U.S. and global financial conglomerates, largely managed by businessmen bereft of professional investment training.a

That situation is made somewhat more dire by the fact that, as the past record I cited earlier showed, equity funds, largely because of their investment costs, already have had a negative Alpha of -1.9% annually over the past ten years.

Actions and Reactions This reaction to the failed investment ethos of the bubble era is entirely consistent with Sir Isaac Newton's third law of motion—for every action there is an equal and opposite reaction. And that law is also in force in the financial markets themselves. The first reaction to the late bubble is that, like all bubbles, it burst. The bear market was the inevitable reaction to the bull market.Stock

0% 5% 10% 15% 20% 25% 30% Telecom. Materials Utilities Cons. Staples Cons. Disc. Health Care Industrials Info. Tech. Energy Financial Share of the S&P 500’s 2006 Earnings, by Sector 3. corporations that compose the Standard & Poor’s 500 Stock Index. (Chart 2) Fifteen years ago, the financial sector share had risen to 10 percent. In recent years, financial sector profits have soared even higher, to an all-time peak of 27 percent. If we add the earnings of the financial affiliates of our giant manufacturers (think General Electric Capital, for example, or the auto financing arms of General Motors and Ford) to this total, financial earnings now likely exceed 33 percent of the earnings of the S&P 500. The finance sector is now by far our nation’s largest generator of corporate profits, larger even than the combined profits of our huge energy and health care sectors, and almost three times as much as either manufacturing or information technology.5 (Chart 3) We’re moving, or so it seems, toward becoming a country where we’re no longer making anything. We’re merely trading pieces of paper, swapping stocks and bonds back and forth with one another, and paying our financial croupiers a veritable fortune. We’re also adding even more costs by creating ever more complex financial derivatives in which huge and unfathomable risks are being built into our financial system.

The average balanced fund incurred annual operating expenses of 1.2% on average during the period, and perhaps another 0.5% in portfolio turnover costs, a total handicap of 1.7%. The index fund all-in cost was 0.2%, an advantage of 1.5% that made up the lion's share of the 2.1 % difference in return. The fact is that the unmanaged index fund had, at the end of this long period, outperformed all but one of the 29 managed balanced funds in the list. This almost universal failure of expensive professional managers to earn pre-cost returns sufficient to pay their keep relative to a passive1y managed index fund suggests how tough it is to break par in the financial markets. Nonetheless, like most investors, you may well prefer to control your own investment balance, and you may well prefer tax-exempt bonds to the taxable bonds held in nearly all balanced fund portfolios. Fair enough. So I tum to a second example of the value of simp1icity-a single equity index fund for your stock portfolio. The identical conclusions we found in our balanced fund analysis prevail agam: 1. Managed equity fund return 14.0%, index fund return 16.5% (using the Wilshire 5000 total stock market Index, a lower hurdle than the large-cap-dominated S&P 500) percentage of market return. Result: 84% ofthe market (look familiar?) for managed funds, 99% for index. 2. After 15 years, managed fund value $70,900; index fund value, $98,600.

Turbulence and Financial Innovation To be sure, financial institutions have held the majority of all U.S. equities for several decades now and their focus on short-term expectations with the attendant high turnover has been in place even longer. So what is it that accounts for the recent surge of market turbulence? To begin with, in this new environment, the raison d’être for money managers, and basis by which they are held accountable, became the maximization of the value of the investments made by their clients, measured over periods as short as years or even quarters. Even as institutional managers turned increasingly to speculation (just as Keynes had predicted), corporate executives became increasingly attuned to short-term profits and the stock-market valuations of their firms. I call this the “happy conspiracy” among institutional owners of stocks and corporate managers and directors to focus more on stock prices—speculation—than on long-term intrinsic values— investment. Another culprit is financial innovation. While innovation is broadly regarded as an unmixed blessing, in the financial sector it is hardly uniformly so. There is a sharp dichotomy it seems to me, between the value of innovation to the financial institution itself—the investment bank, the money manager—and the value of innovation to its clients.

return on their capital, not a return on your (the fund investor’s) capital. They cannot do justice to both, for the record is clear that the more the managers take, the less the investors make. Alas, in the fund industry in the aggregate, you not only don’t get what you pay for, you get precisely what you don’t pay for.  Three, mutual fund returns fall drastically short of market returns. And they fall short by almost exactly the amount of the costs they incurred—all those management fees, operating expenses, sales charges, and hidden portfolio transaction costs. How could it be otherwise? Over the past two decades, for example, the annual return of the average equity fund (10 percent) has lagged the return of the S&P 500 Index (13 percent) by three percentage points per year, largely because of those pesky fund costs. To make matters worse, largely because of poor timing and poor fund selection, the return actually earned by the average fund investor has lagged the return of the average fund by another 3 percentage points, reducing it to just 7 percent per year—roughly 50% of the market’s annual return. Warren Buffett accurately describes the problem: “the principal enemies of the equity investor are expenses and emotions.” The fund industry has failed investors on both counts. An annual return of 7% in a 13% market is a shocking gap, but the long-term reality is far worse.

uncanny ability to recognize the obvious.” For better or worse, I accept that criticism. (Or was it intended as praise?) But our indexing and bond strategies, radical for their time and once considered heresy, have now become dogma. And in the marketplace, they have proven, using the current lingo, to be the “killer apps” of the mutual fund business. Our huge cost advantage has the effect of nicely elevating Vanguard fund performance relative to the performance of our peers. In U.S. equity funds, over the past five years, for example, our average ranking rose from the 41st percentile to the 28th, and international funds, from 68 to 54 (Chart 7). For balanced funds, from 29 to 21. (It gets harder to improve when a fund is already near the top quartile.) For taxable bonds, from 33 to 11; tax-exempt bonds, from 74 to 31. And for money market funds, our percentile soars from the 61st to the 4th. “Out of the commonplace into the rare” might be a fair description of the thrust that low cost delivers to our performance leadership. Given what we observe in most competitive industries—and the mutual fund industry is ferociously competitive in all respects save one, the setting of prices—we might expect our competitive edge in cost to be challenged. But it is not. No fund leader, as far as I can tell, has looked at the market share numbers, called a meeting of his senior officers, and said: “These guys are eating our lunch! Let’s take them on, toe to toe! Now!” That hasn’t happened.

The computer and the Internet have also given us nonstop access to data that allow us to analyze and evaluate mutual funds beyond our wildest dreams, and to make fund selections with unimaginably vast information literally at our fingertips. Never again will mutual fund investors lack the ability to make fully informed investment decisions. From that standpoint, mutual fund investors are among the greatest beneficiaries of the computer revolution. But they are also among its greatest victims. With each passing day, mutual fund investors are proving—as we must have known all along—that in investing, information is all too often mistaken for knowledge; and knowledge is all too seldom translated into wisdom. But, wisdom—far more than mountains of detailed data—and common sense—far more than opportunism—are ever destined to be the prime ingredients of long-term investment success. Communications technology has given us immediate access to abundant information when we are considering our fund decisions—to buy, to hold, to add or subtract, to withdraw entirely. How much information? Consider Morningstar’s Principia database, in which it provides for each of the 3000 stock funds in its database:  For the stock portfolio: price-earnings ratios, growth rates, market capitalization, industry diversification, rate of turnover.  Risk Characteristics: R-squares, Betas, Alphas, standard deviations, Sharpe Ratios.

On an after-tax basis, that negative Alpha in fact nearly doubles to -3.3%. Professional investors all know that successful investing is a tough game. Shareholders know-or should be told with candor-how much tougher it is when fund expenses and taxes are deducted from the managers' returns. For that 3.3% slice removed fully one fourth of the stock market's return in the past decade. It's important to recognize that what's happening here is largely the product of the inordinately high portfolio turnover rates of mutual funds. Twenty years ago, portfolio turnover averaged 30%; today it averages nearly 90%. While individual stocks may be held for decades (and by some managers-Warren Buffett comes quickly to mind-rather successfully) or even generations, mutual funds are rushing to buy and sell their stocks based on transitory changes in price, without concern for tax consequences. The fact is that this behavior sharply reduces the returns generated for their taxable owners. Further, some fund managers are so hair-triggered that many ofthe gains are short-term in nature (less than one year) and are taxed at ordinary income rates. Nearly 30% of fund gains fell into this category last year, and, with the end of the long-standing limitations on "short-short" gains under the new Tax Reform Act, this figure could well increase. Now, portfolio managers can feel free to realize an unlimited percentage of the fund's income in the form of gains realized in less than 30 days.

Second, it has provided just what it promised: performance excellence. On average, the surviving funds delivered an annual return of 12.6% compared to 13.2% for our 500 Index Fund. If we reduce the average fund return by 1.5% to account for the estimated survivor bias, the value of the average fund’s return would drop to 0.1 1000 10000 1933 1941 1949 1957 1965 1973 1981 1989 1997 S&P 500 CRSP Growth of $1, CRSP and S&P 500: 1926 - 2000 Avg. Ann. Return 11.0% 10.6% Correlation 0.98

It’s only a small step from the workings of the financial markets to the consideration of what returns we might expect from stocks in the years ahead. (Our host has asked me to discuss this question.) While only a fool tries to predict what the stock market will do in the short term—there are, alas, lots of fools who do exactly that—predicting long-term returns is largely a product of another set of those simple “relentless rules of humble arithmetic,” similar in concept to the causal linkage between maintaining low investment costs and capturing your fair share of stock market returns. Why so? While in the short-run stock returns are largely shaped by emotions—such as optimism, pessimism, hope, greed, and fear—in the long run they are shaped almost entirely by economics. For example, over the past century, of the 9.6 percent average annual nominal (before inflation) Total Return generated by common stocks, fully 9.5 percent was accounted for by the average dividend yield of 4.5 percent and average earnings growth of 5.0 percent—the Investment Return on capital earned by America’s businesses, The remaining 0.1 percent came from Speculative Return, the willingness of investors to pay a slightly higher price for each dollar of corporate earnings at the end of the period than at the beginning. Since a majority of you here today are not investment professionals, let me put this concept in the homey terms I used in this very hall just a few years ago.

On the other hand, investors in value funds, which rose 11% during the same period, actually had a net cash outflow of $29 billion. Then came the burst in the bubble. The growth group fell 51%, while the value group declined just 11%. It is no secret that when a fund rises 85% and then drops 51%, its net return is not 34%. Its net return is minus 10%. ($1.00 rises to $1.85 and then falls to $0.90). And the once-shunned value funds are down 1% on balance—after all was said 1 Source: Lipper. Fund data adjusted for sales charges. 0% 50% 100% Annual Return Profit on $10,000 Investment S&P 500 Avg. Fund Average Equity Mutual Fund vs. The Stock Market Total Returns, 1984 - 2000 16.3% 13.30%

but also both its management company’s propensity to move managers around, sometimes seemingly at the drop of a hat. Turnover costs can cut your long-term returns by a meaningful amount, so do your best to find funds both with portfolio holdings and portfolio managers that will stay the course. 3. Realize that Taxes are Fund Costs, Too There is yet a third croupier in the fund casino. And in this bull market era, it happens to be the greediest croupier of them all: The Federal Government. Make no mistake about it, Uncle Sam loves the mutual fund industry. For as impatient, aggressive fund managers buy and sell stocks at a furious rate, they pay virtually no attention whatsoever to the taxes such activity will require you to pay. They can ignore taxes, but you can’t. There is awesome value in deferring taxes—and deferring them for as long as you can. When you pay taxes today, that money can’t compound to your benefit tomorrow. Deferring a capital gain for 15 years reduces the present value of each one dollar of taxes to just 41 cents; in 25 years, to 23 cents. Yet fund managers not only require you to pay the 20% tax far too early, realizing long-term capital gains far too prematurely. They also have been realizing some one-third of all capital gains on a short- term basis, thus forcing you to pay taxes at rates up to the 40% maximum on dividend income.

In an earlier era, the Securities and Exchange Commission allowed most such shareholder proposals to be excluded from the proxy because they were related to the “ordinary business” of the corporation. In recent years, however, proposals to limit excessive compensation have often been ruled not subject to the “ordinary business exclusion,” and have been included in proxies. It is high time that owners began to demand that executive compensation be related to the real business achievements of executives in building long-term corporate value. The short-term price of a stock, as we must have learned by now, is an absurd basis for compensation. We ought to be demanding such benchmarks as a company’s five-year return on total capital relative to peers and to American industry in total, and growth in cash flow. How much extra return on capital, or how much cash flow growth should be required for the CEO to earn box-car bonuses, I do not know.cash

inception in 1924 through the early 1960s, fund managers operated largely as prudent trustees of the assets that investors entrusted to them, and put their investors’ interests first. The managers of yore were privately owned, relatively small professional firms whose role was focused largely on stewardship. In the sense, then, that fiduciaries faithfully honored the interests of the actual owners—the mutual fund shareholders—it was indeed the era of owners capitalism, if you will, by proxy. But over the years, the focus of the mutual fund industry has gradually shifted—from management to marketing, from stewardship to salesmanship, and—just as in the case of corporate America—from owners capitalism to managers capitalism. Funds vs. Active Investors—Then and Now One of the main victims of that change came in our industry’s role in corporate governance. As those earlier privately-owned trusteeships whose managers focused on long-term investing in highly-diversified equity funds gradually metamorphosed into giant publicly-held corporations whose managers focused on short-term speculation in ever-more-aggressive specialized funds, portfolio turnover went right through the roof. Up until 1966, it was a rare year when annual turnover exceeded 16%, an average holding period of six months. But today fund managers turn their portfolios over at an astonishing average annual rate of 110%(!), an average holding period of just eleven months. We are no longer an own-a-stock industry.

The author also lauds Vanguard for having “a real and tangible sense of purpose.” However, he points out that my initial vision was a blurry one, and concludes that the public version of our founding is to a degree a myth—albeit “a good one.” But in all, I pass his first test: “Bogle has realized his dream.” “Second, the will to conquer, the impulse to fight, to succeed for the sake, not of the fruits of success, but of success itself.” The Schumpeterian phrase is used in the paper to discuss how I faced a bad situation, by dint, in the author’s words, of “sheer force of will.” But he notes, that without these external circumstances, there is a question as to whether that internal will would have had the opportunity to function. He concludes, doubtless correctly, that “were he not forced to act out of the ordinary, he would not have acted out of the ordinary. . . . because his conservative nature (I’m sure that’s accurate) ensured that his entrepreneurial passions would remain largely checked until circumstances called for their release.” He also believes that my motivations were “not so purely altruistic as the Vanguard myth would suggest.” Fair enough. He also describes me as a fighter, noting that “the fight first to secure Vanguard’s independence and then to see it triumph has been the story of Bogle’s life since 1974.” Further, he refers to the state of war that is said to exist between Vanguard and Fidelity.

Often as again, through God’s grace, Man and woman usher a child Into the world and clothe him in gay colors They cherish him, teach him as the seasons change Until his young bones strengthen and his legs lengthen. Then the poet dealt with the hazards of life that follow birth, as abundant then as now, if very different: Hunger will devour one, storm dismast another. The sword’s edge will shear the life of one. One will drop, lifeless from the high tree. And, then he turns to the rewards of life, stated in the terms of those now-forgotten days. A young man’s ecstasy, strength in wrestling. Good fortune at dice, a devious mind for chess. One will delight a gathering; one settle beside a harp. One will tame the arrogant wild bird, The hawk on the fist, until the falcon becomes gentle. At the Lord’s feet, he hands his treasures. Surely, as this millennium begins, we have the same sense of the world—“an inner questioning along with the stoic spirit of destiny that inspires men and women to keep on battling with the realities of life”—as expressed by that poet from The Year 1000. Hope, as Alexander Pope assured us, springs eternal. Of course we have more today, more information, more health, more wealth, more convenience. God knows we have more things. But what we really need is the reinforcement of our spirit and our moral values, more wisdom, more fortitude, more good humor, grit, and philosophy, more common humanity toward our fellow man.

The Rise of Quantitative Investing And the bad news for traditional managers continues. Another form of index-like competition is emerging, and I’m confident it too will take its place in the field. I refer to what are called “quantitative” investment strategies, which I define to be computer-driven strategies that rely rigidly and exclusively on mathematical formulas to manage investment portfolios. I differentiate the use of quantitative techniques as the foundation of portfolio strategy and selection from the clearly pervasive use of computers to screen and value individual stocks and stock groups as part of the traditional security-analyst-based management process. (“We’re all quants now.”) Today, industry estimates place the assets managed by quants at $100 billion, and the growth rate is strong. Some of these quantitative strategies might fairly be described as the ultimate form of investment relativism. But they must not be confused with closet indexing. With fully disclosed policies and strategies, they are hardly hidden in the closet; their strategies are rigorous and controlled, not random and intuitive; and their costs are often well below conventional norms. (It’s far less costly to run a computer program than to employ a large portfolio research and management staff.) Typically known as enhanced index funds, these funds seek to outpace a market index.

financial goals.” This credo says nothing about aggregate billions of dollars of assets, nor millions of investors, nor Lord forbid, market share, nor even about corporate strategy, nor the need for financial controls, technology support, and focused marketing, although all of them are, to one degree or another, necessary. But they are secondary to our primary goal: to serve the human beings who are our clients to the best of our ability, to serve them with candor, with integrity and with fair dealing. To be the stewards of the assets they have entrusted to us. To treat them as we would like the stewards of our own assets to treat us. This mission is not very complicated, but if you preach it, you’d better live it, every single day. It should go without saying that the same concept of “human beings” should apply to those who serve on our Vanguard crew. (Under penalty of a $1 fine, we don’t use the word “employee,” nor the word “product.”) Those of us who earn our livelihood at Vanguard should treat one another the same way as we would like to be treated. The keys: respect for the individual; recognition that, “even one person can make a difference;” financial incentives to each and every crewmember, based on the rewards we earn for our fund shareholders compared to our peers. Our great crew has made me look good for almost 25 years, and that is the least that I owe to them.

A Failure of Character But there’s more at stake than that. This nation’s founding fathers believed in high principles, in a moral society, and in the virtuous conduct of our affairs. Those beliefs shaped the very character of our nation. If character counts—and, as my book underscores, I have absolutely no doubt that character does count—the failings of today’s business and financial model, the willingness of those of us in the field of wealth management to accept practices that we know are wrong, the conformity that keeps us silent, the selfishness that lets greed overwhelm reason, all erode the character we’ll require in the years ahead, especially in the post-September 11 era. The motivations of those who seek the rewards earned by engaging in commerce and finance struck the imagination of no less a man than Adam Smith as “something grand and beautiful and noble, well worth the toil and anxiety.” I can’t imagine that anyone in this room today would use those words to describe our corporate governance system at the outset of the 21st century. So, yes, too many of our corporate stewards have failed to earn our faith. By focusing on short-term speculation at the expense of long-term investing, we institutional managers have, I fear, gotten the corporate governance that we deserve. Yet most giant institutional investors have been conspicuous only by their silence.

of articles about evil J&J valuing profits over patient safety. Looking closer at the scientific evidence and expert testimony that the jury based its verdict on shows that this conclusion, at the very least, is not entirely accurate. Mineral talc in its natural form contains asbestos, which is known to cause cancer. However, the talc used in J&J’s Baby Powder and other cosmetics has been asbestos-free since the 1970s, according to the company. At the time of Ms Fox’s trial, studies on whether asbestos- free talc caused cancer gave contradictory results. Some studies showed a link to cancer, but the research was dependent on people remembering how much talc they used years ago. Other studies argued that there is no link at all and claimed that there is no link between talc in contraceptives, such as diaphragms and condoms, which would be closer to the ovaries, and cancer. A 2003 meta- analysis, looking at 12k patients found that regular use of talc on the genitals increased the risk of getting ovarian cancer to 0.0161% from 0.0121%. I.e. a real increase of risk of 0.004%, which translates to four extra cases of ovarian cancer for every 1m people who use talc on their genitals, rather than the misleading 33% increase in risk most headlines focused on. The increase was so small that the researchers concluded that it is unlikely to be real, as their data did not show any dose response relationship. Exposure risks generally follow a dose-response curve.

Taking The Toll 3: Fund Selection And investors are also hurt in another perverse way. They have a deep-seated tendency to buy on the basis of past performance, pouring their money into exactly the wrong funds at precisely the wrong time. For example, during the twelve months ended March 2000, when the great technology-age market bubble was inflating to its very bursting point, investors poured $240 billion dollars in technology funds and tech-oriented growth funds at their peak levels, funding some of those purchases by actually withdrawing $40 billion from the value funds that had failed to participate in the great boom. In the aftermath, the asset values of the most popular growth funds declined by an average of 63% from high to low, while the most unpopular value funds actually rose in value by 3%. Combined with the toll taken by fund costs and the toll taken by market timing, this penalty for adverse selection is the third leg of the unfortunate triumvirate of tolls that has left mutual fund investors in the backwater of the returns earned by the financial markets. If financial advisors do no more than keep your client from paying these unnecessary tolls, you’ve made a great start on serving them well! Of course, stock market booms and speculative manias are merely a reflection of the public mood. Tuplipmania, the South Seas Bubble, the Crash of 1929, it is often argued “just happen.

To drive this point home, think of investing as consisting of two different games. Here’s how Roger Martin, dean of the Rotman School of Management of the University of Toronto, describes them. One is “the real market, where giant publicly held companies compete, where real companies spend real money to make and sell real products and services, and, if they play with skill, earn real profits and pay real dividends. This game also requires real strategy, determination, and expertise; real innovation and real foresight.” Loosely linked to this game is another game, the expectations market. Here, “prices are not set by real things like sales margins or profits. In the short-term, stock prices go up only when the expectations of investors rise, not necessarily when sales, margins, or profits rise.” The expectations market is about speculation. The real market is about investing. The only logical conclusion: the stock market is a giant distraction that causes investors to focus on transitory and volatile investment expectations rather than on what is really important—the gradual accumulation of the returns earned by corporate business. And the costs of financial intermediation involved in actively participating in a financial markets dramatically erode those cumulative returns. The Rise of the ETF The simple and unarguable arithmetic that I’ve laid out here is what leads logically to superiority of the index strategy.

This mathematical tautology is what I call the CMH—the Cost Matters Hypothesis—and it explains why the return of the low-cost, all-stock-market index fund consistently outpaces the returns achieved by costly active managers. That is why the Hedgehog beats the Fox. As Archilocus wrote so many years ago: “The fox knows many things, but the hedgehog knows one great thing.” The Intellectual Basis for Indexing2 Indexing—owning all of the stocks in the U.S. market is that one great thing. It works, as it must. At the outset, the intellectual basis for indexing was the EMH—the Efficient Market Hypothesis—which suggests that by reflecting the informed opinion of the mass of investors, stocks are continuously valued at prices that accurately reflect the totality of investor knowledge, and are thus fairly valued. But the reality is that sometimes the stock market is efficiently priced, and sometimes it is not. But few—if any—investors can consistently tell which is which. But 2 What, one might ask, is the intellectual basis for active management? I know of none.

domination in 1973-1983—but one of seven decades in the period—large caps were actually superior. Annual returns: large cap +11.1%, small cap +10.4%. In any event, the relationship between large caps and small stocks, if not entirely dominated by RTM, is permeated with the force of market gravity. We don’t have an historical chronicle of comparable length to those I’ve used for my first examples of RTM. So, for the evidence in U.S. versus international stocks, I can rely only on data for the past 38 years. Here, as shown in Exhibit VII, we again see profound evidence for my thesis. Here, I’ll compare the returns of the Standard and Poor’s 500 Stock Index and the Morgan Stanley Capital International Europe, Australasia, and Far East (“EAFE”) Index. While there were frequent swings to and fro, our ratio of cumulative value slightly favored the EAFE Index for the first 24 years through 1984. The compound returns were EAFE +9.7%; S&P +8.4%. Then EAFE exploded, outpacing the U.S. by fully two times during the brief 1984-1988 cycle. Since then, the U.S. has fully repaid the compliment, more than redressing that flash of EAFE brilliance during the subsequent nine years. For the full period, the compound returns on U.S. stocks and international stocks were identical at +11.5%. The relative value of each initial $1.00 invested by the investor who stayed in the U.S. was worth precisely the same for the internationalist.

When we apply to the annual data that remarkable magnifying glass called compounding, we can describe the investment returns earned by the fund—on cost and tax assumptions that I think we can all agree are hardly excessive—as shocking. The investor lost 63% of the market’s cumulative return to the intermediaries, 66% of that to taxes, and 85% of that to inflation, ending up with just 2% of the compound market return we calculate from all of those annual return data that the fund industry publishes. 13.3% 11.1% 8.7% STOCK MARKET MUTUAL FUND AFTER EXPS. MUTUAL FUND AFTER EXPS AND TAXES Stock Market Returns, 1950-1999 Annual Returns Final Value of $1,000 $514,000 $193,000 $65,000 STOCK MARKET MUTUAL FUND AFTER EXPS. MUTUAL FUND AFTER EXPS AND TAXES 9.3% 7.1% 4.7% Real Returns, 1950-1999 Annual Returns Final Value of $1,000 $85,000 $31,000 $10,000 STOCK MARKET MUTUAL FUND AFTER EXPS. MUTUAL FUND AFTER EXPS AND TAXES STOCK MARKET MUTUAL FUND AFTER EXPS.TAXES

“Why talk about correcting the present evil? The patient has a cancer. The virus is in the blood. He is not only sick unto death, but he is dangerous to the community. Call in the undertaker.” When Great Grandpa Armstrong wrote those words, he was the same age as the apple of his apple’s apple when my own new book, “Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor,” was published two months ago. While my book about mutual funds is rather more temperate than his about life insurance, it makes the same point: “. . . the industry has embraced practices that seriously diminish its shareholders’ chances of successful long-term investing . . . Mutual funds should provide the greatest sum of investor returns with the least management expense, (but) the natural order has been turned on its head. The result not only defies nature, it offends common sense . . . Common sense demands that funds be governed in the interests of those who own them.” With your help, we can accomplish that goal.

Such projections ignored the fact that the remarkably innovative, technology-driven, rapidly changing, dog-eat-dog New Economy would be highly competitive. When you think about it, the Internet was hell-bent on creating the most remarkable medium for unfettered price competition ever designed by the mind of man. Crowning the consumer as king, obviously relegates the producer to the status of the king’s subjects. How could we have ever expected that giving “power to the people” could possibly provide a license for boundless corporate profitability? Old Economy vs. New Economy Meanwhile, back at the Old Economy, the NYSE market seemed virtually immune to the bubble plague that so thoroughly infected the New Economy. Why? Simply because we believed we were in a boom in which the New Economy was in the driver’s seat. And the core of the New Economy was technology, with all of the “come hither” promise of a sultry siren. Only two of the NYSE’s largest 25 stocks are tech stocks, but only two of the 25 largest stocks on NASDAQ are not tech stocks.telecommunication

As the bear market of the past year makes clear, investing in stocks is risky:  First, there is individual stock risk. We have seen some stocks soar and some plummet, with little means of knowing which stock will do which, and when. Who would have expected that Cisco, whose $500 billion market capitalization a year ago made it the largest stock in the world, would soon plummet by 80%, erasing $410 billion in value?  Second, there is style risk. Growth funds trumped value funds during the first nine years of the decade, rising an amazing 609% through last March, more than double the 281% increase for value funds. Since then, growth funds have fallen 38% on average, while value funds have actually risen 5%, erasing nearly the entire growth fund and their cumulative records are now virtually identical. Who among us is wise enough to know how to “time” those changes?  Third, there is manager risk. A growth fund manager, for example, may outpace his peers, or may fall short, and the difference is apt to be enormous. Consider that in the past decade, the top decile of growth fund managers produced an average annual return of 17%, almost three times the 6½% return for the bottom decile. How would you go about picking the winners in advance? Happily, each and every one of these three risks can be easily eliminated. For when you own the entire stock market through an index fund, there is neither individual stock risk, nor style risk, nor manager risk. Only market risk remains.

Capitalism and Values The idea that ethical values and service to the community of investors should be intimately embedded in the practices of business, of course, was also an important underlying theme of my idealistic thesis of 56 years ago. That old idealism remains with me intact—heck, it is even stronger!—today. So I’ll now turn to some thoughts on what business careers should be all about, and on the meaning of success. I hope that my reflections will be especially helpful to you students as you begin to consider your role in this opportunity-rife, risk-ridden modern world, and what contribution you can make to mankind. I turn these ideas as a good preacher should, with an anecdote. The Reverend Fred Craddock, a remarkable preacher from Georgia, may have been imagining things—the way preachers are wont to do—but he says this story really happened. Dr. Craddock was visiting in the home of his niece. There was this old greyhound dog there, just like the ones who race around a track chasing those mechanical rabbits. His niece had taken the dog in to prevent it from being destroyed because its racing days were over. Here’s how Dr. Craddock recounts the conversation. “I said to the dog, are you still racing?” “No,” he replied. “Well, what’s the matter? Did you get too old to race?” “No, I still had some race in me.” “Well, what then? Did you not win?” “I won over a million dollars for my owner.” “Well, what was it? Bad treatment?

lower level. It was our obligation to fill that gap, and to give with an open hand. And, truth told, I wanted our hand not only to be open, but eager to help. I’m hardly an expert on the Rochester community, but as an investor I do know that there’s been some creative destruction going on in upper New York state, too. One of your largest old stand-bys is no longer headquartered here, and another is in the battle of its life to adjust both to the dog-eat-dog competition wrought by globalization and to the stunning pace of technological innovation in the digital revolution. So as new businesses spring up in this splendid region, I urge the entrepreneurs who have settled here and those who will follow them—the creative destroyers, if you will—to fill the inevitable gap in community giving. I’m confident that no comparable gap exists in the needs of those in this community who need help. Indeed, if you’re like Philadelphia, that gap in between resources and needs is doubtless larger than ever. There is so much work to be done that the sooner we all roll up our sleeves and open our purses, the better. How to Give Now, I can’t imagine that anyone here tonight will not participate in this year’s United Way campaign. But I would like to mention a very special extra way you can show your support, by making a commitment that will help insure United Way’s future, come what may. It’s called Planned Giving.

Exhibit VI: Percentage of Risk Premium Consumed by Expenses Fund Expense Equity Risk Premium Group Ratio 2% 3% 4% Lowest Cost 0.2% 10% 7% 5% Average Cost 1.5 75 50 38 Highest Quartile 2.2 110 73 55 Looking out over time, from the price levels in today’s market, a 2% risk premium might be a reasonable guess for the coming decade. Indeed, many respected investment advisers might place the probable number at less than 2%. Well, I’m often wrong (seldom in doubt), so first let’s explore what a normal equity premium might be. I went to the acknowledged authority on the subject, best-selling author (Stocks for the Long Run) and Wharton School Professor Jeremy J. Siegel. He obligingly sent me a two-century history of equity premiums on U.S. stocks over long-term U.S. Treasury bonds. It is reproduced in the chart below. The average equity premium over this long, long period is 3.5%. I will leave it to you to decide what is a fair number to use today, but, for the rest of my analysis, I’m going to rely on this average. So, let’s imagine you are an investor confronting the real world of mutual funds today, and examine what happens when you

Exchange Index. The NASDAQ Index fell a stunning 78% from its high to its low last autumn, while the NYSE index fell 33%, less than half as much. (The principal difference between the two markets is that to be listed on the NYSE a company actually has to have earnings.) In the ensuing recovery, the NASDAQ index is up 73%, and the NYSE up 30%. But, don't forget the surprisingly harsh mathematics of compounding: A 78% loss followed by a 73% gain nets, not to a 5% loss, but a 62% loss! And even a 33% loss balanced by a 30% gain results, not in a 3% loss, but a 14% loss of capital. But we've clearly been told a tale of two markets: Reversion to the mean is alive and well. Chart – A Tale of Two Markets: Growth of $1, 1982-2003 Today, after the fall—and a nice recovery—what does the future hold? Let's look at some numbers that might help us to understand what returns might lie ahead for the stock market, and for the bond market as well. I, for one, place little credence in simply looking at historical experience, for as I've said a thousand times, "financial returns are not actuarial tables." The watchword of investing is uncertainty. To understand why the past cannot foretell the future, we need only heed Lord Keynes' words, written nearly 70 years ago: "It is dangerous . . . to apply to the future inductive arguments based on past experience, unless one can distinguish the broad reasons why past experience was what it was."

But in the late 1970s, another source of shareholder activity began. As the concept of the fund family took hold, the exchange privilege came into wide use. Investors could redeem shares in, say, the family’s value fund and buy its growth fund or, for that matter, its money market fund—still clearly a redemption, but not “counted,” as it were, in the official data, understating the true redemption rate of fund investors by more than half. From the mid-1980s through 1997, regular redemptions of equity funds averaged some 17% of assets. But exchange redemptions ran at an even higher 19% rate, bringing the typical year’s all-in redemption rate to 36%, a holding period of less than three years for the average shareholder, fully 80% shorter than the 14 year average of the 1950-1975 era. In 1987, with the short-lived market crash and its aftermath, there was a rare departure from this norm. Redemptions jumped to 20% of assets and exchange redemptions (largely into money market funds) leaped to 42%, a combined redemption rate of 62%. In October alone, the annualized rate soared to 120%. (That’s right, a rate that, had it persisted for a year, would have been larger than the entire equity fund asset base!) That rate may well be a harbinger of what lies ahead if stock market conditions move from unsettled, as they are today, to bearish. In any event, the upward trend seems to be accelerating.

1. An independent director should serve as board chairman. 2. No more than one management company director should serve on the board. 3. Independent directors should select their own successors, without management participation. 4. The board’s legal counsel should be completely independent of the management company. I’m delighted to note that the recent rules promulgated by the SEC deal with the last two issues. But even without SEC rules, a strong board could take appropriate action on the first two issues, opening the door to the Board’s focusing solely on the interests of shareholders. To use this independence to bring reasonableness to fund fee full levels, one more change would help. Mutual fund directors should review not only expense ratios, as is the custom, but expense dollars. The Board should demand that the manager provide an accounting for each dollar of fund assets that are spent—the sources (investment advisory fees, 12-b1 fees, etc.), and the uses (investment management, distribution, operation, manager’s profits, taxes, etc.), of cash resources for each fund and for the entire complex. Studies prepared by fund consultants should also report the dollar amounts of fees paid by peer funds, as well as their expense ratios. What might this examination of sources and uses show? Let me present just one extreme example, using a money market fund. Why a money market fund?

Together these aggressive funds gathered the staggering total of $237 billion of additional investor assets during the year and one-quarter immediately preceding the market peak, withdrawing $23 billion from their value funds during the same period, precisely the reverse of what they should have done. At the market high, $2.1 trillion of assets of fund shareholders was invested in the New Economy aggressive growth funds, nearly twice as much as the $1.1 trillion of investor assets in value-oriented Old Economy funds. Since then, the former group has dropped by an average of 40%, while the latter group is off just 4%. No, it wasn’t the fault of technology that the superficial investment appeal of technology stocks lured millions of investors into these new funds. Rather, the mutual fund industry bears the responsibility for doing the luring—creating the aggressive new funds, promoting them to the skies, and then watching them self-destruct. The idea of making what will sell rather than selling what we make, always lingering in the industry’s background, lurched to the fore during the great bull market, and the investing public paid the price. Happily, there was at least one area in which technology helped to improve the lot of some investors.

Public Domain, Not Private Profit Vanguard provides at least one parallel with Franklin’s concept of placing his inventions in the public domain rather than seeking private profit. Vanguard’s innovative structure was designed to reduce the claims against investment returns by institutional managers and distributors to the bare minimum, the better to enhance the residual returns remaining for investors. Shortly after we began operations in May 1975, it occurred to me that the best way to bring our common sense principles of investing to their logical conclusion: Since an index of stock market prices provides a fine replication of the actual returns earned by the entire stock market, then investors could capture almost 100% of that annual return simply by owning the market at nominal cost. This obvious insight quickly led to the simple invention that has been the most powerful manifestation of Vanguard’s philosophy of mutuality—the world’s first index mutual fund. A Thesis in 1951, An Index Fund in 1975 But that was not the first time that the idea had occurred to me. Some 25 years earlier, in my Princeton University senior thesis on the mutual fund industry, I had written that mutual funds “could make no claim to superiority over the market averages,” and that mutual funds should, above all, serve their investors, and serve them “in the most honest, efficient, and economical way possible.” Those insights were based solely on anecdotal data.

You shall teach us your song’s new numbers, And things that we dreamed not before: Yea in spite of a dreamer who slumbers, And a singer who sings no more. So go now and lead, in any way you can. Make some music, whether you lead a world- class orchestra that shakes the rafters, or perform a solo in a quiet corner. Move and shake the world, in ways large and ways small. Hold your ideals high. Dream your own dreams. Make them come true. Just go out and do it. May God bless each one of you.

The more years you smoke, the greater your increased risk of lung cancer. However, this relationship was not seen for genital talc use and ovarian cancer. Two more large-scale studies followed in 2013 and 2015, which relied on self-reported data and found no dose- response or any increase in risk of cancer. Ms Fox’s case was used as a precedent for others to come forward and sue the company. By March 2017, over 1,000 women in the United States had sued J&J for not warning customers about the possible cancer risks from using its Baby Powder. In July 2018, a St Louis jury awarded a record-setting $4.7bn in damages to 22 women after they claimed J&J talcum powder caused their ovarian cancer. In December 2018, Reuters publishing a story alleging that J&J knew since 1971 there were small amounts of asbestos in its Baby Powder and ignored it. The Reuters report suggested that it’s probably “impossible” to completely purify mined talc and definitely impossible to test for asbestos, which is a known carcinogen, thoroughly and conclusively in all commercial batches. Juries in New Jersey and California found that J&J was not to blame for two other women’s cancer and that, the company didn’t mislead consumers about the risk of talc-based products.

Many state taxes—and Massachusetts, I need not remind you, is hardly the most tax-friendly state—consume even more of these unnecessary fund gains. So look for tax-efficient funds—not only those that have been so in the past, but those that have policies that emphasize on going tax-efficiency. 4. Be Careful About What You Pay for Fund Selection Advice Many investors need sensible advice in fund selection and asset allocation—and many do not. If you are convinced you do not need advice, it is unwise to pay for it, either in the form of front-end sales commissions (about 5% of the amount invested), or 12b-1 sales fees included in a fund’s expense ratio (up to 1% of assets), or fees paid to registered investment advisers and financial planners, usually beginning at about 1% of assets and paid directly by the investor. I have no hesitancy in saying that some of these providers of fund selection advice can be characterized as croupiers.see

” “Oh, no,” the dog said, “they treated us royally when we were racing.” “Did you get crippled?” “No.” “Then why?”, Craddock pressed, “Why?” The dog answered, “I quit.” “You quit?” “Yes,” he said, “I quit.” “Why did you quit?” At last, the reason: “I just quit. Because after all that running and running and running, I found out that the rabbit I was chasing wasn’t even real.” While I’ve received more accolades than I could ever deserve during these later years of my own long career, I must confess that even I challenge myself as to whether the rabbit I’ve been chasing is real. I have little doubt, however, that our Vanguard crew and our clients believe that the rabbit I’ve been chasing in my career—essentially the mission to give investors a fair shake in their quest to accumulate assets for a secure future—is real. And of course it is. So what’s bothering me? Perhaps it comes down to how a friend, many years ago, defined “success”—a word that I don’t particularly care for—as consisting of wealth, power and fame.three

Given the inevitable mathematics of the stock market that I described at the outset, the industry began to develop passive, low-cost mutual funds that assured a market-like performance, and thus virtually guaranteed superiority over peer funds. The index fund could merely buy all of the stocks in the market and hold them forever, paying no advisory fees, engaging in no costly portfolio trading, holding administrative and marketing costs to rock- bottom levels, and charging no sales loads. While its concept is simple—buying American industry and holding it forever—however, its implementation is not.Growth

Because here the conflict is clear: The manager seeks to charge high fees so as to maximize the return on its capital; the fund wants to pay low fees so as to maximize the return on its capital. And the amount of the fee represents virtually the sole differentiation in return. We’ll follow the money in a $61 billion group of money market funds managed by a large financial conglomerate. In 2000, the funds paid some $254 million in management fees, $64 million in distribution fees, and $71 million in shareholder service fees and operating costs. Total: $389 million, equal to 0.63% of assets. (Chart 7.) The fees spent on distribution and shareholder services probably cover the cost of those services. What about the amount spent on investment management? Consider a good-sized money market fund, regularly rolling over short-term U.S. Treasury bills and high-grade commercial paper, with absolutely no hope of materially exceeding the returns available in the money market.but

 Past Performance: annual and cumulative returns, monthly and rolling three months, rankings versus a market index, and versus peer groups; tax-adjusted returns.  Investment styles: a matrix of nine boxes sorting fund both by growth or value characteristics and by size of market capitalization, i.e., large cap growth funds. (And funds must maintain their “style purity,” no matter what.) Portfolio manager experience, education, and tenure.  Costs: sales charges, 12b-1 fees, expense ratios. (By the way, please never ignore costs!)  And the summum bonum: The “Star” rating, based on risk-adjusted returns relative to other equity funds. It is no exaggeration to say that the superb Morningstar service provides all the information an investor could possibly need to evaluate a fund’s characteristics, to understand a fund’s character, and to make informed decisions.information

Heavily motivated by self- interest, the providers of financial services are to organize the instrumentalities of business and government—let’s call them stocks and bonds—into packages and, well, “products” that earn profits for themselves, even as they are also designed to serve the perceived needs of investors. Some of these innovative products are simple and cost-efficient; others, at the extreme, are mind- bogglingly complex and expensive. What’s more, our institutions have a large incentive to favor the complex and the costly over the simple and the, well, cheap; quite the opposite, I would argue, of what most investors want and need. Given recent events in the financial markets in which some of our nation’s—and the world’s—mightiest financial institutions have collectively already taken some $170 billion (estimated to total an astonishing $300 billion when all’s said and done) of write-downs from their forays into relatively new, untested and complex financial instruments that I described earlier—let alone the hundreds of billions of losses experienced by their clients. Innovation, often in the name of making our U.S. markets more competitive while foreign markets, has once again gone too far.

and done, an advantage of nine percentage points. The message: Sweet selling is sour stewardship. The counterproductive result of this business of over-marketing and promotional hype is that the returns actually earned by mutual fund investors are even worse than the inferior returns shown in my earlier study. How much worse? Don’t take my word for it. Look at the figures reported by the fund industry’s largest firm:2 With the S&P 500 providing an annual return of +16.3% since 1984 and the average fund earning 13.1%, the return earned by the average mutual fund investor was just +5.3%(!) Nearly 40% of the fund return vanishes into thin air when we take into account where investors actually placed their money. It turns out that fund investors earned not 80% of the stock market’s annual return, but 33%. And not 60% of the market’s cumulative wealth, but 12%, because the $120,000 profit earned by simply owing the market compared with but $14,000 for the average fund investor. Is the mutual fund industry meeting the needs of individual investors? You tell me. 2 Source: Fidelity. -$60 -$40 -$20 $0 $20 $40 $60 $80 $100 Q1'99 Q2'99 Q3'99 Q4'99 Q1'00 Value Funds Growth Funds Period Total Growth: $238 Value: ($29) When Marketing Replaces Stewardship: Net Cash Flow into Growth and Value Funds (in billions) 0% 50% 100% Annual Return Profit on $10,000 Investment S&P 500 Avg. Equity Fund Investor Average Equity Fund Investor vs. The Stock Market Total Returns, 1984 - 2000 16.3% 5.33%

11.1%1, and an investment of $1,000,000 made on August 30, 1976 would have grown to $14.1 million; the final value of the same investment in Index 500 would have grown to $22.7 million. Interestingly, the difference of $8.6 million was almost exactly the same as the $8.5 million index fund advantage reflected in the 30-year study of fund performance that I presented to the Vanguard directors when I proposed the first index mutual fund way back in 1975. Clearly, the index advantage has remained substantially intact over the years. If 55 years of experience constitutes a reasonable standard, stock indexing has met the test of time, and its wisdom now seems beyond reasonable challenges. The Wisdom of Bond Indexing While it is seldom acknowledged, bond indexing works every bit as well as stock indexing. Indeed, because the returns of individual bond funds have such a high cross- correlation, the index advantage is even more obvious. It took me until 1986 to get around to starting Vanguard’s Total Bond Market Index Fund, and it has been an unarguable investment success2, outpacing fully 170 of the 192 managed bond funds that survived the subsequent 15 years. Since the fund’s inception at the close of 1986, our bond index fund has delivered a return of 8.0% per year, vs. 7.

The economic value to mutual fund shareholders created by this change in the law is not entirely clear to me. It is highly unlikely that fund turnover will slow so greatly as to mitigate the gain realization issue. First, the fact is that reducing a fund's turnover from 150% to 100% simply doesn't matter. Substantially all gains are realized fairly quickly. Authoritative studies suggest that turnover rates would have to be reduced to 20% or less to make a material improvement in the tax burden. But the fact is that any turnover whatsoever, by giving up the value of that implied interest-free loan, has a negative impact. What happens when the basic strategy of a fund calls for limited turnover? Something very good for fund investors. The tax bill falls, and the after-tax return rises accordingly. It is as simple as that. For as taxes are deferred, returns rise significantly with each additional year that an investor elects to hold fund shares. And through tax elimination-for example, if an investor's heirs receive the shares with a stepped-up cost basis at the time of the investor's death-after-tax return leaps upward. Nonetheless, even if, as a policy matter, good intentions exist to reduce turnover, it obviously soars-and substantial gains are realized-when a new portfolio manager is brought in to manage a fund.asset

Why? Because taking on Vanguard would require aggressively challenging us with low-cost index funds, low-cost bond and money market funds, and low-cost conservative stock funds focused on long-term investing. The fact is that the returns of the clients of our rivals—their fund shareholders—would be markedly enhanced, but the returns of their own management firms would be slashed—no matter how much their market share improved. In the face of the competitive edge we have created, the industry’s silence has been, well, deafening. Their service- profit chain, simply put, is different from ours. For there’s no profit for fund managers, or so it seems, in giving their clients—the owners of their funds—a fair shake. Low Cost Fosters Service Leadership But what of our service leadership? The fact is that our service leadership in the mutual fund industry has been achieved, not despite our low costs, but because of our low costs. To explain this seeming contradiction, I must explain the basic economics that underlie our cost advantage. It will cost about $1.150 billion to operate Vanguard this year. With average assets in the $480 billion range, our ratio of expenses to assets will be 0.28%.operates

But if we can distinguish the reasons why the past was what it was, we set some reasonable expectations about the future. Keynes helped us make this distinction by pointing out that the state of long-term expectation is a combination of enterprise ("forecasting the prospective yield of assets over their whole life") and speculation ("forecasting the psychology of the market"). I'm well familiar with those words, for 52 years ago I also incorporated them in that thesis at Princeton. Investment Return and Speculative Returns This dual nature of returns is clearly reflected in stock market history. Using Keynes' idea, I divide stock market returns into: a) Investment Return (enterprise), consisting of the initial dividend yield on stocks plus their subsequent earnings growth; and b) Speculative Return, the impact of charging price/earnings multiple on stock prices. Consider the record of stocks during the twentieth century: Note first the steady contribution of dividend yields (the yellow bars) to total return during each decade; always positive, only once outside the range of 3% to 5%. Note too that, with the exception of the depression-ridden 1930s, the contribution of earnings growth (the green bars) was positive in every decade, usually running between 4% and 7% per year. Result: Total investment returns (the line at the top) that were negative in only a single decade (again, the 1930s), and generally ran in the 8% to 13% annual range.return

flow growth each year for five consecutive years. That strikes me as a shareholder-friendly approach! And that only begins the list of where owners should get involved. No, I don’t think our giant institutions have the talent and ability to manage the businesses they effectively own. But they ought to demand the right to approve large mergers and acquisitions, and the right to eliminate anti-takeover provisions, staggered boards, and poison pills, and the right to say grace over dividend policy, indeed the right to submit to a vote of shareholders any proposal that is designed to assure that a company is managed in the interests of its shareowners. Changing the System These changes will require SEC initiatives, and I confess to being disappointed in the Commission’s recent proposals to give shareholder access to nominating directors. Given the pressure from The Business Roundtable, it’s easy to understand the tortuous process that has been proposed: In year one, a “triggering event” with high trigger must take place—only a shareholder holding at least 1% of the company’s shares could propose shareholder access, and if the proposal won a majority vote (or if there were a 35% vote to withhold support from one of the directors), then in year two shareholders who have held at least 5% of the company’s stock for at least two years could nominate up to three candidates, and bear the costs of trying to persuade other owners to vote for their candidates.

stocks had come to represent 77%(!) of the value of the NASDAQ Index, but just 24% of the NYSE Index. The idea that technology stocks would lead the way into a New Era proved to be an extraordinary popular delusion, but it was a delusion that was fomented by those who had a vested interest in creating the delusion: First, the matter of earnings. Lacking a history of those stodgy old earnings that we know are what drive investment return, the tech companies in the NASDAQ—at least in their early years—were valued solely on investor confidence—hope and greed, if you will, both of which spring eternal until fear comes along—to drive their speculative return. Despite the fact that earnings expectations lost all touch with reality, the appetites of the entrepreneurs and the investment bankers created innumerable centi-millionaires (and more than a few billionaires) through a rash of 492 Internet IPOs (of which perhaps only 25 are now selling above their initial offering prices). What was different about the NYSE? Well, a listed stock must have, of all things, earnings. And not only earnings, but earnings history. Specifically, a listed company had to have a history of at least “three consecutive years of . . . demonstrated earning power,” as well as substantial net tangible assets. In the new high-tech offerings, both qualities were conspicuous by their absence.

So I set about collecting and tabulating the results of each of the equity funds in the mutual fund industry, then a laborious effort. (Today it could be done almost instantaneously.) Over the previous thirty years, I found, the average mutual fund had lagged the results of the rather obscure index I had chosen—the Standard & Poor’s 500 Composite Stock Price Index—by 1.5 percentage points per year—just the evidence I needed to convince the world that the index mutual fund was an idea whose time had come. To add weight to my argument, I assumed an initial investment of $1 million in the average fund and in the 500 Index, and compounded the average returns of each over the three- decade period. Final value: S&P 500 Index, $25 million; average equity fund $16 million. A nine million dollar increment! Although those mathematics were powerful, the investment world was not yet convinced. Neither were the Wall Street underwriters of the fund’s initial public offering, nor the stock brokerage fraternity, nor, for that matter, the man on the street.new

I’ve been talking about it, arguably, since 1951, when I mentioned the failure of mutual fund managers to beat the market (even then!) in my Princeton senior thesis. But it took me until 1975 to start the world’s first index mutual fund (Vanguard Index 500), and its tiny $11 million IPO was something of a failure (“Bogle’s folly”). But over the next quarter century, indexing took hold, and today the assets of index mutual funds now total more than $1 trillion, about 16 percent of the assets of all equity funds. But it is ironic that while mutual fund indexing continues to grow apace, the means by which investors index has taken a U-turn—a U-turn for the worse. Classic indexing has been overwhelmed by what I call indexing nouveau, represented by the exchange traded fund (ETF). The ETF is simply an index fund designed to facilitate trading in its shares, dressed in the guise of the traditional index fund. Think of the differences: First, if long-term investing was the original paradigm for the classic index fund of 30 years ago, surely using index funds as trading vehicles can only be described as short-term speculation.widely-diversified—

” And in the recent bubble, the information age, globalization, “the long boom,” and the turn of the millennium simply combined to create an era of unreasonable expectations. Investors, it is said, have no one to blame but themselves. Please don’t believe that. To do so is to ignore the role of the professional investors—and professional marketers—who helped create the aura of omnipotence that enveloped the financial community. Just like those Wall Street security analysts who gave us the “research” that inspired the internet stock craze, as well as Enron, Global Crossing, and scores of other watered stocks—all in the name of capturing more investment banking clients—along with those corporate insiders who purchased stocks through low-cost options and quickly sold them at inflated prices; so too many mutual fund managers accepted uncritically the hyped-up growth projections for technology, medical, and telecommunication stocks, and piled them into the funds they manage. And that’s not all that the mutual fund industry must answer for.and

I may have called it that, but I really look at it as a fair competition between two firms with approaches toward investors that are polar opposites—philosophically, conceptually, and strategically. He adds a word about my 35-year fight to conquer a failing heart, capped by the miracle of receiving a new one just one just eighteen months ago. I guess those three examples are a fair basis for him to affirm my fighting impulse. The Yale senior concludes this section by agreeing that I’ve enjoyed success for its own sake, not for its fruits, for I own none of a company worth (his guess, and fair enough) between five and ten billion dollars. When he says, in a neat term of phrase, “once a man has more than enough for himself, only the fool measures his success in terms of coin and treasure.” Entrepreneurs or not, we should all take heed of that thought. “Third, the joy of creating, getting things done, of simply exercising one’s energy and ingenuity.” These words, the author argues, are at the heart of the Schumpeterian understanding of the entrepreneur. He finds this evident in the innovative Vanguard structure and in the creation of the first index fund. This innovation, he points out, “was scorned by the investment community . . . but today is hailed as the hallmark of responsible investing.‘the

come to make your asset allocation decision. For the purpose of argument, let’s assume you expect to maintain a stock-bond ratio of 65%/35%, and you determine to consider the implications of cost on your decision. Further, let’s assume a long-term return of 10% on stocks and a risk premium of 3.5% over long- term Treasuries. You decide to hold a Treasury bond for the bond allocation. For the equity allocation your choice is between a fund in the lowest cost range of 0.20% and an equity fund in the highest cost quartile, with an expense ratio of 2.2%. Here are the differences in the returns on the two programs: Exhibit VIII Annualized Return Low-Cost Fund High-Cost Fund Equity Allocation 9.8% 7.8% Bond Allocation 6.5 6.5 65/35 Composite 8.6% 7.3% The resulting 1.3% spread in assumed return—with risk (the stock/bond ratio) held constant—it is safe to say, is a meaningful difference. The low-cost program would build your $10,000 to $22,800 in 10 years and $78,700 in 25 years (taxes excluded). The respective results for the high-cost program would be $20,200 and $58,200. But now let’s look at the situation slightly differently, from the standpoint of risk premium. You accept my basic premises—a 10% return in stocks and a 3.5% equity risk premium—and are investing with the hope and objective of receiving a long-term return of 7.5%. Question: what allocation would you make, given a choice between a low-cost equity fund and a high-cost equity fund?

(Ihis $27,700 gap is what this industry has cost its equity fund investors during the great bull market.) Final value as percent of market, 67% vs. 97%. This industry consumed one-third of the market return! "My how mightily your money grows when costs are minimized!" 3. Costs, again, are the villain of the piece. The 2.5% annual lag compares with about 2.2% in estimated fund expenses and turnover costs. As you can see, this IS-year equity fund comparison-just as in the case of the balanced funds-amply justified a simple index approach to capture the highest realistically-possible portion of the market's annual returns-in this case, again, 99%. It is fair, of course, for you to say: "Well, the index fund is always fully-invested in stocks, so why not hire a manager, who can reduce stock holdings in anticipation of market declines?"sound

The first mutual fund in this category began in 1986, and has slightly bettered the index itself, by enough to give it a significant edge over an index fund. The overall evidence of success in such “disciplined” and/or “sector neutral” strategies, as they are known, is quite mixed, but my guess is that they’ll prove attractive to investors who realize the value of indexing, but can’t quite abandon all hope that they can identify in advance active managers who will outperform. Other strategies—sometimes known as “Positive Alpha” or “market neutral”—are based on achieving, not a rate of relative return, but an absolute rate of return. These strategies may gain an advantage by their ability to use specialized investment techniques (including short- selling, hedging, etc.) and often rely on strict quantitative discipline. These managers may gain an advantage by capitalizing on the fund industry’s Achilles’ heel: asset size. When assets under management are limited, the drag of transaction costs is held within tolerable levels that do not themselves frustrate the implementation of aggressive investment policies.these

It can be as simple as a codicil in your will making a gift to your United Way Endowment Fund (this is what I have done), or in making an irrevocable gift of cash or securities to a collective charitable endowment fund, now broadly available through community donor- advised funds, and through leading mutual fund firms, including Vanguard. In such a program, your gift of $25,000 or more is invested in a balanced and diversified stock/bond account, and you get an immediate tax-deduction for the full market value of the gift. You can then make annual contributions—usually at least 5% of principal—to qualified charities such as the United Way. You can add tax deductible contributions of up to $5,000 at a time, gradually increasing what is in effect your own private foundation, which keeps on giving until the principal is exhausted. You can also use a collective endowment fund to establish a charitable remainder trust, offering an immediate tax-benefit and providing you with a lifetime stream of income, with the principal going to the United Way on your death.investment

When compounded over this grand 20-year era for investing, and adjusted for inflation, the average investor has captured but 16 percent of the market’s compounded real profit. (I’m not kidding! $1,000 invested in a simple index fund mimicking the Standard & Poor’s 500 Stock Index in 1984 and held today produced a profit of $5,490 after inflation; for the average fund investor, the real profit came to just $910.) No wonder that David Swensen, the integrity-laden and remarkably successful manager of the Yale endowment fund, characterizes such a shortfall as “the colossal failure of the mutual fund industry.” Where is the Public Discourse? It ought to be obvious that there is an urgent need to face up to these and other failures in the changing world of capitalism.“the

“When enterprise becomes a mere bubble on a whirlpool of speculation,” as the great British economist John Maynard Keynes warned us 70 years ago, the consequences may be dire. “When the capital development of a country becomes a by-product of the activities of a casino, the job of capitalism is likely to be ill-done.” 5 For the record, the 2006 operating earnings of the S&P 500 totaled $787 billion. The earnings of the major sectors (in billions) were: Financials $215; Energy $121; Health Care $79; Manufacturing and Technology each $81.

If I’m right about the challenges we face in America and the world, we shall need this reinforcement. One hundred years ago, Woodrow Wilson said, “a new age is before us, in which we must lead the world . . . the spirit of the age will lift us to every great enterprise, but the ancient spirit of sound learning must also rule.” And so it is this evening, as we enter a new millennium.

We are a rent- a-stock industry, a world away from Warren Buffett’s favorite holding period: Forever. But while a fund that owns stocks has little choice but to regard proper corporate governance as of surpassing long-term importance, a fund that rents stocks could hardly care less. The 1949 Fortune magazine article that led me to write my Princeton senior thesis about mutual funds, which in turn got me my first job in this business, shows how much our attitude toward corporate governance has changed. Fortune wrote, all those years ago, that mutual funds were “the ideal champion of . . . the small stockholder in conversations with corporate management, needling corporations on dividend policies, blocking mergers, and pitching in on proxy fights,” even as the SEC was calling on mutual funds to serve “the useful role of representatives of the great number of inarticulate and ineffective individual investors in corporations in which funds are interested.” Back then the industry owned less than two percent of all stocks. Yet even though our ownership has soared to 23 percent, it was not to be.

In fairness, an index fund modeled on the Standard & Poor’s 500 Index would also have fallen well short of the index itself, but still performed quite remarkably relative to the mutual fund. Assuming costs of 20 basis points, its 13.1% return would have compounded to $471,000 vs. $193,000 for the fund; after a 120 basis point charge for taxes (index funds are typically about twice as tax-efficient as ordinary funds), its net total value would be $276,000 vs. $65,000. And the Index fund total would have been cut to $45,000 after inflation, vs. $10,000. That too may seem like a far cry from $514,000, but it’s hardly realistic to eliminate taxes from the real world of investing. The important reality is that the Index fund would have provided 2.4 times the after- cost value of the mutual fund, 4.2 times the fund’s after-tax value, and 4.5 times the fund’s real terminal value. Yes, Embedded Alpha is a powerful destructive force. What Active Managers Can Learn From Indexing Paraphrasing the Greek philosopher Horace, I fear that, like the mountains, the financial giants and fund managers who developed the ML/BARRA study have “labored and brought forth a mouse.” Had they made their own calculations of annual Embedded Alpha, then compounded the resultant return over the long-term, and then considered the reality that costs and taxes are paid in current dollars but long-term returns are received in real dollars, they would have realized the enormity of the issue.

If the past year, demonstrates nothing else, it surely demonstrates that stock market risk, standing alone, is quite substantial enough, thank you. 5. Diversify, Diversify, Diversify Diversifying Investment Styles: Growth Funds vs. Value Funds $4.42 $7.09 $4.01 $3.81 $0 $1 $2 $3 $4 $5 $6 $7 $8 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 .Funds

Over the long run, then, RTM has clearly manifested itself in global equity markets. I’ve now illustrated the powerful force of the law of relative market gravity, if not with Sir Isaac's precision.2 His discovery of the law of universal gravitation has been described as the high point of the Scientific Revolution of the 17th century. To be sure, the utility value of mean reversion to investors in diversified equity funds and in stock market sectors that I have described here will hardly be the high point of this fading century. But RTM is a principle borne out by history, even though it may take decades to appear. The intelligent investor will ignore it at his or her peril. Indeed, Newton’s third law: “every action has an equal and opposite reaction,” is perhaps even a better translation of what happens in the financial markets. I’m willing to stake my own retirement investment strategy on the fact that it will continue to exist. 3. RTM in Common Stock Returns Let me now turn to my third area of mean reversion: the long-term returns of common stocks. Here, unlike the previous two areas on which I’ve just commented, RTM relates, not to relative but to 2 For the record, his equation: Force = G m1m2/d2; i.e., force equals the relative masses of two objects divided by the distance squared, times the gravitational constant.

whether or not markets are efficient, investors as a group must fall short of the market return by the amount of the costs they incur. Therefore, we don’t need to accept the EMH to be index-fund believers. There is a better reason for the triumph of indexing, and it is not only more compelling but unarguably universal. As I mentioned earlier, I call it the CMH—the Cost Matters Hypothesis—and it is all that we need to explain why indexing must work and does work, and it in fact enables us to quantify with some precision how well it works. Investors, in totality, are the market. On average, those investors must be, well, average. But investors fail to match the market’s return precisely by the total of their investment costs. By matching the market with only minimal costs, indexing is mathematically certain to win. Whether or not the markets are efficient, the explanatory power of the CMH holds. Enter Paul Samuelson More than a century has passed since Louis Bachelier, in his Ph.D. thesis at the Sorbonne in 1900, wrote: “Past, present, and even discounted future events are (all) reflected in market price.” Nearly half a century later, when Nobel Laureate Paul Samuelson discovered that long- forgotten thesis, he confessed that he “oscillated . . . between regarding it as trivially obvious (and almost trivially vacuous), and regarding it as remarkably sweeping.” But the words of Bachelier and others seem to have lit a spark of interest that would lead to Dr.

Then, I explained stock market returns with a, well, crusty speech entitled “The Bagel and the Doughnut.” The date was January 5, 2000, almost precisely at the stock market’s peak; the occasion, a meeting of Philadelphia’s Sunday Breakfast Club. In my remarks, I relied on an analogy inspired by William Safire in his essay, “Bagels vs. Doughnuts.” These baked goods, Safire tells us, are similar in shape but different in character: Bagels are “serious, ethnic, and hard to digest. Doughnuts are fun, crumbly, sweet, and fattening.” Investment return, I argued, is the bagel of the stock market, reflecting the reality of intrinsic business values. Its underlying character is nutritious, crusty and hard-boiled. Speculative return is the spongy, tempting, and sweet doughnut of the market itself, reflecting investment expectations and driven by the illusion of momentary stock prices, however precise. The bagel-like economics of investing are almost inevitably productive in the long run; the doughnut-like emotions of investing are fickle and largely unpredictable—witness the Great Bull Market of the 1980s and 1990s, and its collapse in 2000-2002, almost entirely the result of a change in the doughnut of investing from the soft sweetness of unbridled optimism on the part of investors to the acid sourness of pessimism.

I’ve read lots of books and articles about business management and corporate strategy, but I’ve never seen the phrase “human beings” as representing the key to business leadership. But when I think of both our clients and crew, that phrase has been the key to everything we’ve accomplished. Maybe the theorists and strategists are right to ignore it, but it has worked for us. Simplicity and human beings. That’s about it. Where leadership comes into play, I’m not quite clear. But we’ve got lots of marvelous leaders at Vanguard. Not just the “big-shots,” but the crew—above and below decks, those who shoot the cannons and those who load them, those who take in the sails and man the sheets— those who make the ship sail and navigate the course. Above all, my goal was to have a crew of servant-leaders, the phrase Robert Greenleaf chose to apply to an institution in which everyone is part leader, part servant, all human beings who care, and who want to lift those whom they serve and those with whom they serve alike. Yet someone has to be the leader, and I’ve tried not only to set the values and shape the strategy, but to make them clear and unmistakable. To use the right words from the world’s most magnificent language.on

The all-in redemption rate rose to nearly 40% in 1999, and in the first three months of 2000 has soared to 50%, reflecting an abandonment of value funds, a surge in technology funds, and, to a small degree, a flight to money market funds. This sea change in the character of fund owners, from long-term to short-term, violates the most fundamental principle of investment success: Invest for the long pull. I am confident that this frequent switching causes investors to relinquish far more investment return than can be explained by the high out-of-pocket transaction costs and taxes they incur. Rapidly jumping from one fund to another is not a formula for investment success. Yet these appalling figures of aggregate redemptions are, as far as I know, almost never presented to fund directors, who remain unaware of the shifting nature of their constituency and the added risks and costs to which the funds they serve are exposed.

If we simply act as good corporate citizens and recognize that ownership entails not only rights but responsibilities, we will again get the governance we deserve. And our clients will benefit accordingly. If we all take the initiative to stand up and be counted, we will at last return to an era in which the great creative energy of American business and finance shifts from its short-term focus on the price of a stock—speculation—to a long-term focus on the value of the corporation—enterprise. When we do, our corporate stewards will respond appropriately, and that change will well-serve both investors and our nation. 3. Faith In Our Trustees For in addition to the troubled financial markets and the failings of the stewards who run our corporations, the trustees of the investment dollars of American families—the pension funds, the mutual funds, and other financial institutions—have also failed to live up to the faith investors have placed in them. To explain how this situation has come about, we need first to understand the simple mathematics of investing: The returns earned by investors in the aggregate inevitably fall well short of the returns that are realized in our financial markets.very

fund began operations with only $11 million in assets. While what quickly became known as “Bogle’s folly” had an infinitely modest beginning, however, it was a beginning. It took two decades of energy and persistence for us to bring that tiny original index fund to its present eminence. But today its assets of some $90 billion mark it as the largest mutual fund in the world. We made no attempt to patent the investment, and indeed “freely and generously,” in Franklin’s words, encouraged others to follow suit. And while some of our rivals copied it, however, their high cost structures precluded success. Even without a patent, the index fund has become our trademark, the backbone of the Vanguard book of business. Together the assets of our stock index funds, our bond index funds (another of our inventions, if an obvious one), and our other funds that are managed with index-like strategies total $410 billion, all because of that original invention of 1975. Opportunity and Motive Just as Franklin’s desire to enhance the public weal undergirded his invention of the Franklin stove and the lightning rod, so Vanguard’s investor-friendly mutual structure undergirded the invention of the index fund. While I was hardly the only person who understood the simple principles behind the index fund—there must have been hundreds of others—the traditional fund firm would have had little interest, regarding it with suspicion if not horror.

Mutual Fund Costs Are Declining ICI Position: Ownership cost of equity funds down 40%. • 1980 231 bps; 1998 135 bps (Load 200 bps, no-load 83 bps). Specific Flaws: 1. Weighted by sales volume. Unweighted expense ratio up 64% — 96 to 158 bps. 2. Lowest cost decile up 28% from 71 bps to 90 bps (1997). 3. Ignores hidden cost of portfolio turnover (50 to 125 bps). 4. Ignores opportunity cost (60 bps). 5. Ignores fees on “wrap accounts.” 6. Amortization of sales loads based on 25 year-old data. If updated, 1998 cost up by 50 bps, to 185 bps (estimated). Fundamental Flaw: Price competition is (correctly) defined by the actions of producers, not the actions of consumers. Thus price competition is not “intense” in fund industry; it is barely alive. Myth #4: 1 1 0 1 2 0 1 4 1 1 5 2 9 6 1 5 8 1 3 9 9 0 1 0 0 1 1 0 1 2 0 1 3 0 1 4 0 1 5 0 1 6 0 1 7 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Average Equity Fund Expense Ratio (basis points) Mutual Fund Costs Are Declining ICI Shareholder Costs - 1998: Average 193 bps Avg. Sales-Weighted: 135 bps Avg. Asset-Weighted: 132 bps 1998 Total Cost: $ 44.0 B 1980 Total Cost: $ 0.8 B Myth #4: 1999

not taxing. With office space, computers and other services, it might be possible to get the investment management costs for these money funds to $5 million—with a generous dollop of indirect overhead, perhaps even to $10 million. Now let’s do the subtraction: $254 million in management fees, minus, say, $10 million of cost. Result: a net profit of $244 million to the manager. In the money market field, where it is virtually impossible for even the best manager to add even the smallest value, and where each million dollars paid to the manager reduces by one million dollars the return of the shareholder, such a huge diversion of returns would be obvious. But only if the watchdogs are watching. Despite the collegial atmosphere and self-interest involved, when the watchdogs finally get the numbers and follow the money they’ll be compelled to take action that brings fund fees down to realistic levels. The same principle—the more to the manager, the less to the shareholder— applies to investment-grade bond funds, to bond and stock index funds, and in the long-run, as the data make clear, to most actively-managed stock funds. Costs matter. And directors ought to examine them thoroughly. I’ve looked at the industry this evening in its broadest aggregates. It may well be that none of the funds you serve is subject to the sharp criticisms I’ve raised.

promptly adjust for any changes in the index, to value its portfolio accurately and promptly, to coordinate daily cash flows with portfolio activity, and to create the market-like baskets of stocks that have proved so useful in managing its portfolio. Overall, then, technology has not resulted in the creation of better products. Through no fault of its own, it has facilitated the creation of worse products—especially the New Economy funds that represented one of the great crazes in mutual fund history, making fund investors poorer by scores of billions of dollars. But on the plus side, technology has helped the index funds to track the market even more efficiently, enriching investors simply by assuring them of their fair share of financial market returns. (3) Better Information for Investors? Hardly surprisingly, it is in the area of investor information that the Information Age has shone its brightest. Through fund evaluation services such as Morningstar, Value Line, Strategic Insight, and the like, open networks provide data about mutual fund portfolios and performance so vast as to be beyond the ability of the human mind to absorb. Never again will mutual fund investors lack the ability to make fully-informed investment decisions. From that standpoint, mutual fund investors are among the greatest beneficiaries of the information revolution. Fund information is surely rife, and accessible at a moment’s notice.

to enhance their knowledge. Rather, they rely on a fund’s past performance and star rating. Our trust is placed “in our stars, not in ourselves,” precisely the opposite of what Cassius told Brutus. But the “stars” do not give investors the power to select future winners. While Morningstar’s information is priceless in understanding a fund’s investment style, past returns, and present portfolio, the evidence strongly suggests that it is virtually worthless in enabling investors to enhance their returns. Technology has made information accessible without providing knowledge and without engendering wisdom. Perhaps a rereading of the Book of Proverbs would remind us of what is really important: “Get wisdom, get insight.” The Quality of Advice With all the information and commentary that is available on Internet websites, I find myself particularly troubled by the offering of investment and financial planning advice. This advice is voluminous and comprehensive, giving investors the ability to plan their financial futures with decimal point precision, and to manipulate the data to their hearts’ content, raising and lowering their expected retirement plan contributions, their allocations to stocks and bonds, and their assumptions about future returns in the financial markets, about tax rates and inflation rates, and about retirement age. But, at bottom, the data that is provided tacitly ignores the most fundamental characteristic of investing: Uncertainty.

By the middle of 2019 J&J was in the midst of 11,000 lawsuits alleging that Baby Powder usage caused cancer, primarily ovarian and mesothelioma. This led the House Oversight Committee’s Subcommittee on Economic and Consumer Policy in the United States to focus its first meeting of the year on Baby Powder and whether it needed stricter federal regulation. J&J continued to insist that its products are safe and asbestos-free and that tests done by the US Food and Drug Administration (FDA) had not found any asbestos. In December, J&J commissioned 155 tests by two different third-party labs using four different testing methods on samples from the same bottle tested by an FDA contracted lab earlier in the year. This FDA contracted lab had found asbestos in the sample earlier in 2019 and this led to J&J voluntarily recalling the production lot of Baby Powder the sample came from. The tests conducted by J&J found that there was no asbestos in any of the samples, supporting the findings of a smaller number of independent tests done in October. In the last few weeks of the year, researchers from the National Institute of Environmental Health Sciences in North Carolina published a paper analysing data from 253,000 women (a much larger sample than the 2003 study) to assess whether using talcum powder on one’s genitals increases the risk of developing ovarian cancer. Of these women, 2,168 (0.9%) went on to develop ovarian cancer.

So if you can’t be certain about the future—and who among us can?—“diversify, diversify, diversify” remains the essence of wisdom. Pillar 6. The Eternal Triangle. Never forget that risk, return, and cost are the three sides of the eternal triangle of investing. Remember also that the cost penalty may sharply erode the risk premium to which an investor is entitled. You should understand unequivocally that investing in a fund with a relatively high expense ratio—more than 0.50% per year for a money market fund, 0.75% for a bond fund, 1.00% for a regular equity fund—bears careful examination. Unless you are confident that the higher costs you incur are justified by higher expected returns, select your investments from among the lower-cost no-load funds. Up-to-the minute evidence reaffirms exactly what I demonstrated in my book. During the past decade, the lowest-cost decile of money market funds provided an average annual return of 5.1%, 11% above the return of 4.6% for the highest-cost decile. For the lowest-cost decile of intermediate-term bond funds, the return was 7.8%, 24% above the return of 6.3% for the highest- cost quartile. And for the lowest-cost decile of large-cap equity funds (excluding index funds), the average return was 13.1%, fully 18% above the return of 11.1% for the highest-cost decile. (Low-cost bond index funds and low-cost stock index funds, I should note, provided even higher returns than their low-cost counterparts that were actively managed.)

aggressive growth funds during the final years of the mania, all designed to bring in public money into our coffers rather than to help investors achieve their long-term financial goals. We also have to accept our responsibility for, right at the market peak, promoting the living bejebbers out of our hottest performing funds. The 44 equity funds that advertised their performance in the March 2000 issue of MONEY magazine for example, reported an average return of 85.6% during the previous year. The End of Fund Dominance? Well, if the mutual fund investors haven’t come within a country mile of capturing the returns of the financial markets, and if they are predestined to fall short of whatever returns the stock, bond, and money markets are generous enough to provide in the future, why doesn’t this era of mutual fund dominance deserve to come to an end? Why shouldn’t separate accounts move to center stage? Forrester Research is hardly alone in suggesting that these accounts—individually- managed, customized investment accounts that can take into consideration each investor’s objectives, tax-status, and personal predilections, all the while providing real time reports of portfolio holdings—will do exactly that. Well, I, for one, doubt it.

developing quantitative approaches—Enhanced Indexing and Positive Alpha—represent important challenges to the status quo. The Changing Role of the Traditional Active Manager Faced with this competition, how should the traditional manager respond? If closet indexing is the wrong response, indeed a counterproductive one—as I believe it is—what is the right one? First, a given: today and for as far ahead as the eye can see, each adviser should freely acknowledge that he or she should be expected to outpace an agreed-upon market performance standard over the long run, and strive to do just that. What else is an adviser supposed to do? How else can we measure whether any economic value being created is sufficient to justify the cost of retaining the adviser in the first place? Of course, the standard need not necessarily be the S&P 500 Index (though it would be appropriate for large cap funds with a blended—growth stocks and value stocks—style). Broader all-market indexes will also become part of the world of investing. And other styles may also be considered as standards. Indexes measuring returns for style/market cap “boxes” (nine, under the Morningstar system) will also become part of our world. It is simply unrealistic for small-cap managers, or mid-cap managers (or for that matter high-cost large-cap managers, though they have the best chance) to duplicate the long-term record of an all-market index.

aristocracy of our moneyed corporations” in the quotation that I cited a few moments ago. Yet remarkably, little public discourse has been in evidence. In the investment community, I have seen no defense of the inadequate returns delivered by mutual funds to investors, nor of the industry’s truly bizarre, counterproductive ownership structure. No demand by institutions to gain the rights of ownership that one would think are implicit in holding shares of stock. No serious criticism of the virtually unrecognized turn away from once-conventional and pervasive investment strategies that relied on the wisdom of long-term investing, toward strategies that increasingly rely on the folly of short-term speculation. And, until recent months, almost no discussion of the profound problems we are facing in our various systems of retirement plan funding. If my book helps to open the door to the introspection on these issues by our corporate and financial leaders that is so long overdue, followed by corrective action, perhaps the needed changes will be hastened. This process must begin with a return to the original values of capitalism, to that virtuous circle of integrity—“trusting and being trusted”—that I mentioned at the outset. When ethical values go out the window and service to those whom we are duty-bound to serve is superseded by service to self, the whole idea of the capitalism that has been a moving force in the creation of our society’s abundance is soured.

attributes don’t represent success. They represent the fruits of success, and I’ve seen enough of life to be absolutely sure that each one is a false, mechanical rabbit. In business, I fear, too many think of defining wealth in terms of dollars and cents, rather than of family, friendships and contributions to society; of defining fame by newspaper headlines and television appearances, rather than in reputation among colleagues and contemporaries; and of defining power as power over the corporate purse and over corporate persons, rather than intellectual and moral power. But I hope each of you will define your own success in these latter terms. For you students, there’s plenty of time for that later on in your lives. The point is to ask yourself whether you want to chase the illusory rabbit of success—defined by our conventional assessment of wealth, fame, and power—rather than the real rabbit of meaning—defined by integrity, virtue, and inner strength, doing our best with whatever talents that the Lord has been kind enough to endow in us. Think with me for a moment about those whom we can all agree are chasing real rabbits—teachers and scientists, sculptors and painters, historians and musicians, authors and poets, physicians and surgeons, jurists and true public servants, ministers and priests and rabbis.

absolute, returns. The fact is that for more than two centuries the U.S. stock market has demonstrated a profound tendency to provide real (after-inflation) returns that surround a norm of about 6.7%. As shown in Exhibit VIII,3 the swings around this norm over moving 25-year periods are reasonably narrow, with returns much above ten percent in only 7 of the 172 periods and returns much below four percent in another 5 periods. In short, real returns have ranged between roughly 4% and 10% in 93% of the 25-year periods, a remarkable record of consistency. Surely RTM is alive and well in the stock market. The standard deviation of returns in 25-year periods—about one-half of an investing lifetime for most investors today—is 2.0%. In fairness, in a shorter time frame of ten years, the standard deviation is 4.0%; in an investment lifetime of 50 years, it is a minuscule 1%. So time horizon makes a meaningful difference. The root cause of these long-term returns is fundamental: corporate dividends plus the growth of corporate earnings. And, using data we have available from 1871 forward, we can measure the extent to which these two financial fundamentals have dictated the returns earned on equities. Real corporate earnings have grown at an annual rate of 3.9% since 1871; real dividend yields have averaged 2.8%. So, the total fundamental return on stocks has been 6.7%. This figure precisely matches the actual real return of 6.

costs incurred by those who would help investors to beat the market themselves constitute the reason that investment managers as a group are destined to fail at the task. Why? It is only to state the obvious when I point out that all investors as a group must of necessity earn the market returns—but only before the costs of investing are deducted. After these costs are taken into account—after all of the fees, the transaction costs, the distribution costs, the marketing costs, the operating costs, and the hidden costs of financial intermediation—investors must—and will—incur a loss, indeed a loss precisely equal to the aggregate amount of those costs. Beating the market before costs is a zero-sum game; beating the market after costs is a loser’s game. Management of Embedded Alpha At long last, this reality has taken root, even among financial market participants who are not among the lowest-cost players in the game. Consider the paper entitled Success in Investment Management: Building the Complete Firm, prepared two years ago by Merrill Lynch and BARRA Strategic Consulting Group after consultation with a distinguished list of money managers that included Fidelity, Putnam, and Citigroup. The study reached this major conclusion: Management of Embedded Alpha, the frictional costs of running a portfolio, will emerge as an essential contributor to investment performance. (It’s about time!)

principle, but a failed practice. In fact, fund managers have done precisely the reverse. For example, equity funds held an average cash position equal to about 12% of assets at the start of the great bull market. Near the recent market highs, fund cash had been cut to only 5% of assets, providing little protection against the decline that ensued. Being bearish when you should be bullish, and bullish when you should be bearish, is not a formula for investment success! Chart 12 The case for indexing, then, is the very essence of simplicity: owning the entire U.S. stock market or bond market; putting aside the fruitless attempt to select the best manager; holding the asset allocation fairly constant; making no attempt at market timing; reducing transaction activity, minimizing taxes; and eliminating the excessive costs of investing that characterize most mutual funds. And it works. But, I'm a realist. I recognize that in the real world, lots of all-too-human traits get in the way of a simple, all-encompassing index fund approach. "I'm better than average;" "I can pick the best funds;" "Even if the game is expensive, it's fun;" "It can't be that simple"-are all too common refrains in the minds of investors-am I speaking for you?-who choose to pursue the conventional strategy of relying entirely on actively-managed funds to implement their investment strategies. "Hope springs eternal." But if the beginning of simplicity is the index fund, it need not be the end.

incessantly on television, in the press, even on billboards. Remember this: Those are your dollars the managers are spending to bring in new investors, and there is simply no way under the sun that they can bring any benefit whatsoever to you. Consider whether you want to contribute to this cost: if not, tell them about it. I also have no hesitancy in saying that there are many investment advisers and brokerage executives for whom the term “croupier” is in no way appropriate. Indeed, the best advisers are exactly the opposite: they can help you minimize the costs of the croupiers in the stock market casino by steering you toward funds with low expenses, low turnover, and high tax-efficiency. Equally important, they can also help you to minimize the many pitfalls of fund selection, provide you with sound asset allocation guidance, and give you personal attention. If you are among the many investors who need this sort of advice, carefully select your adviser. And be sure to know exactly the fees and charges involved. Rule 5: Add up the Costs and Values in the Market Casino You owe it to yourself to consider the sum total of the costs of the market casino, in the light of the financial values you seek there. The costs of fund investing have gotten completely out of hand.

In that January 5, 2000 speech, I considered the outlook for the stock market during the first decade of the new millennium. I asked just two questions: (1) Will the bagel of investment fundamentals give us its usual sustenance? And (2) Will the doughnut of speculation get even sweeter than it was when I spoke, or will it finally sour again? Here’s how I answered the first question about investment return: Since the dividend yield on stocks was then at an all-time low of just over 1 percent, it was sure to contribute little to future investment returns. (Remember that the long-term norm was 4 ½ percent.) As to earnings growth, ever the optimist, I guessed that 8 percent growth might be possible. Thus, the economics of investing suggested an investment return of 9.2 percent—the 1.2 percent yield, plus 8 percent earnings growth. My answer to question (2) about speculative return: The bullish emotions that had driven stock returns skyward during the 1990’s, could not recur. After all, stocks were then selling at 30 times earnings; almost double the long-term norm of 16 times. (What was the market thinking?!) I suggested that P/E ratio would drop to perhaps 20 times, slashing 4 percentage points per year from the projected investment return of 9.2 percent, thereby reducing the total return on stocks to about 5 percent during the first decade of the 21st century, only about one-half of the long-term norm of 9.6 percent.

Answer: If you select the low- cost program, your required ratio would be 30% stocks and 70% bonds. But if you select the high-cost program, your ratio would be 75% stocks and 25% bonds. To say the least, the difference in risk exposure is dramatic. Put another way, you could reduce your exposure to the risk of the stock market by 45 percentage points—a reduction of 60%—by the simple expedient of choosing the low-cost fund. This example obviously assumes that other factors are held constant, in effect, that costs make the difference in long-term performance. (I have amply highlighted the basis for this thesis earlier in this paper.)assumes

them with new traditions. To be persistent in pursing the mission. To look ahead as far as my vision can see, and to speak out on our goals with the zeal of a missionary, the stubbornness of an idealist, and the soul of a street fighter. To be as smart as my limited brain-power will allow. It is up to others—indeed to history—to evaluate what it is this one human being has accomplished, and the extent to which Vanguard shareholders—indeed all mutual fund shareholders—have been served by the voyage of the HMS Vanguard. But I know, as I hope you know after hearing these comments, that whatever the answer is, it would never have come to pass if I had not come here as a young man quite by accident of fate, and fortuitously discovered, indeed often at exactly the opportune moment, the Golconda that began with FORTUNE Magazine in 1949, and then Walter Morgan and Wellington Fund; then my family; and then Vanguard itself and the “Vanguard” name; and then the first index fund and the novel distribution strategy—one diamond after another right here in my own backyard, just as Russell Conwell’s words promised that I would. All that I had to do was dig for them. Oh, yes. I referred earlier to that one other diamond I found here. Paradoxically, it was a diamond in the form of a heart. (And as we all know, in games of cards, a heart beats a diamond every time.) It’s true in life, too.

Samuelson’s intense study of the financial markets. In essence, Bachelier’s conclusion was, as far as he went, right: “The mathematical expectation of the speculator is zero.” But to be tested in practice, his theory has to be taken one step further. The mathematical expectation of the speculator is not zero. It is a loss equal to the amount of transaction costs incurred. So, too, the mathematical expectation of the long-term investor must fall short of whatever returns our financial markets are generous enough to generate for us—or mean enough to inflict upon us.

planning include using the proceeds of tax-deferred IRAs and 401-k thrift plans, which, left in your own estate or that of your spouse, are subject at first to inheritance taxes and then to income taxes. In fact, your tax-deferred plan assets should usually be first in line for contributions in your estate plan—ahead of your own direct investments—for income in respect of a decedent (IRD) establishes not only the usual tax deduction, but avoids income taxes that would otherwise be paid by your heirs. Further, a tax law change last year now makes it possible for the first time to make partial distributions of tax-deferred plan assets to charities. Yet another avenue you might want to explore is any deferred compensation from your employer to which you may be entitled. Left to your heirs, Federal and state income taxes can consume up to 45% of the gross proceeds when the deferred compensation is distributed, followed by Federal and state inheritance taxes of up to 60%. It would not be unusual for your (non-spouse) beneficiaries to end up with just 22 cents out of each dollar in your plan. (That’s not as bad as it sounds; don’t forget that you’ve never paid a penny of income tax on that deferred pay.) If you have, as I do, six children, then, each would end up with less than four cents per dollar that is due me.

0% for the average bond mutual fund, that one percentage point difference is accounted for largely by the costs of investing (an expense ratio advantage of about 1 Actual survivor bias is probably considerably higher. Princeton’s Burton Malkiel estimates it at 4.1% per year during the 15 years ending in 1991, and it would doubtless be even larger over 25 years. 2 I apologize for using the Vanguard bond and balanced index funds in these comparisons, but our Total Bond Market Index Fund is the only publicly-available such fund with a long history; our three defined- maturity bond funds are still unique; and our Balanced Index Fund remained one of a kind until 2000. $0 $5 $10 $15 $20 $25 500 Index Fund Avg. General Equity Fund Millions The Wisdom of Stock Indexing Growth of $1,000,000: Aug. 1976 - Oct. 2001 $22.7 Avg. Ann. Return: 500 Index: 13.2% Avg. Fund: 11.1% $14.1

sectors of the market offers less diversification and commensurately more risk. Third, if the original paradigm was minimal cost, it’s clear that holding market sector index funds that are themselves low-cost obviates neither the brokerage commissions entailed in trading them nor the tax burdens incurred if one has the good fortune to do so successfully. And as to the fourth and final, quintessential aspect of the original paradigm—assuring, indeed guaranteeing, that you will earn your fair share of the stock market’s return—the fact is that an investor who trades ETFs—and especially sector ETFs—has nothing even resembling such a guarantee. The typical ETF investor has absolutely no idea of what relationship his or her investment return will bear to the return earned by the stock market itself. But, after all of the selection challenges, the timing risks, the extra costs, and the added taxes, I’d bet on a substantial shortfall. (Think Gotrocks here.) But the fact is that, despite the demonstrated success of the classic indexing strategy over three decades now, the growth in market share of traditional index funds stopped dead in 1999, at 10 percent of equity fund assets. All of the increase since then—the remaining 6 percentage points of that 16 percent total has come in ETFs. This stampede into exchange traded funds (ETFs) has been dominated overwhelmingly by highly specialized funds that, in the words of an ETF advertisement, “can be traded in real time, all day long.

1. Remember that the mathematics are immutable. Explicitly recognize and acknowledge that investment success—not just in the long-run, but every day of every week, and every month of every year—is defined by the apportionment of market returns between investors on the one hand and financial intermediaries on the other. 2. Reduce basic advisory fees, but endeavor to maintain firm revenues by incorporating incentive/penalty fees. These actions will reward the successful firm and penalize the unsuccessful. (They will, of course, reduce the total level of industry-wide advisory fees.) 3. Cut operating and administrative costs. This may mean less awesome views of America’s most magnificent skylines and harbors, less lavish entertainment, fewer client junkets, fewer seminars in Bermuda, less glossy presentations, less first-class travel, and more modest wine cellars . . . the whole nine yards. 4. Reduce marketing expenses to the bare-bones level. Advertising is expensive! Special note to the mutual fund industry, where some firms’ annual marketing budgets exceed $100 million: Those expenses raise serious questions of fiduciary duty, questions about whether the investment interests of fund clients are playing second fiddle to the marketing interests of the adviser. 5. Take a hard line on transaction costs. Even more importantly, take a hard line on transactions.

size of the funds they are leaving has impeded their ability to deliver outstanding returns. The fact is that today the average fund portfolio manager has an average tenure of just three and one-halfyears. To say that these are especially critical issues for wealthy investors considering investing in mutual funds in the accumulation and distribution of their estates would be a powerful understatement of the issue. As James P. Garland, President of The Jeffrey Company, has observed, "Taxable investing is a loser's game. Those who lose the least-to taxes and fees-stand to win the most when the game's all over." In an article in The Journal of Investing [Spring 1997], Garland presents an imposing case, comparing the performance of two $100 investments over a quarter century: one in an idealized index-assuming no expenses, turnover, or taxes-and one in a mutual fund with an expense ratio of 1%, a turnover rate of 80%, a capital gains tax rate of 28%, and an income tax rate of 36%. The terminal market values are strikingly different: $1,721 for the index versus $706 for the fund. This example dramatically illustrates the powerful long-term impact of costs and taxes. By the end of 25 years, the government has consumed 47% of the optimal ending dollar amount, while the manager pocketed 12%, leaving the investor with only 41 % of the investment on an after-tax, after cost basis. And it is the investor who put up 100% of the initial capital.

If mutual fund shareholders are the losers, who are the winners? Why, the financial intermediaries! Specifically, the owners of fund management companies, whose annual pre-tax profits came to as much as $25 billion in 2000 alone. FORBES magazine’s recent list of the 400 Richest Americans gives us some idea of how well fund managers do. The list includes 15 billionaires (or, in fairness, near billionaires) whose wealth is derived from the profits they have made by managing other people’s money—an average nest-egg of $2 billion. It’s a living! One can imagine that more than one of these rich Americans owns a yacht of the type that inspired the classic question: “Where are the customers’ yachts?” (Today, it may be a G-5 jet.) If fund costs ate up a large chunk of the profits of investors in an era of 16% stock returns, just imagine what will happen when returns are lower. If I’m right that future returns may be in the 6% to 9% range, a 3% cost would consume, not 20% of the annual return, but 33% to 50%; not 40% of the cumulative profit, but 75%. Fund costs will also take a substantial toll on that 4¼% Treasury bond return and that 2% money market yield. So wise investors had best be aware, not only that costs have mattered in the past, but that costs will matter more than ever in the years ahead. Yes, costs always matter.

If a majority of shares approved, likely some years after the company first got into trouble, there would be a small change in the board. While well-intentioned, the SEC proposal is too severe. Given that nearly all institutional investors have demonstrated far more willingness to vote for a reform proposed by others than to propose a reform on their own, a proposal for access should require only some reasonable dollar holding (say, $25 million to $100 million). Further, any group of institutions who hold more than, say, 10% of a company’s shares for at least two years should be exempt from the limitations, able to propose new directors, or even an entire slate, in the proxy without delay, and with costs reimbursed by the company. Opening up the director nomination process is only one of the major issues that must be resolved if we are to return capitalism to its owners.and

punctuate the chart. (blue bars), as price-earnings ratios waxed and waned. (A 100% rise in the P/E, from 10 to 20 times over a decade, for example, would equate to a 7.2% annual speculative return.) Curiously, without exception, every decade of significantly negative speculative return was immediately followed by a decade in which it turned positive by a correlative amount—the quiet 1910s and then the roaring 1920s, the dispiriting 1940s and then the booming 1950s, the discouraging 1970s and then the soaring 1980s—RTM writ large. And then, amazingly, we see an unprecedented second consecutive exuberant increase in speculative return in the 1990s—a pattern never seen before. Now look at the 20th century in total: the average annual return on stocks during the century was 10.4% (orange bar). Nearly 10% was represented by investment return; 5% by dividend yields and about another 5% by earnings growth. The remaining 0.6% came from a small net increase in the price-earnings ratio. The message is clear: In the long run, stock returns depend on the reality of the investment returns earned by business. The perception reflected by speculative returns counts for little. Over a long span of years, economics dominate long-term equity returns; emotions, so dominant in the short- term, dissolve. Returns in Retrospect, and in Prospect As 1999 ended, looking at the reasons behind past stock returns would have helped us recognize a bubble that was about to burst.

Mutual Funds and the Governance Failure This industry’s notorious passivity on corporate governance issues means that we bear no small share of the responsibility for the ethical failures in corporate governance, the excessive executive compensation, the earnings overstatements, and the co-opting of accountants that we’ve seen during the recent era. But it’s going to take a lot of work to bring mutual funds into a 21st century world of increased investor activism, for we face a profound conflict of interest when we come to vote the shares of the corporations whose pension and 401(k) assets we manage. In addition, our own weak governance system—where separately owned management companies essentially control their associated funds—places us in the role of people who live in glass houses: We’ve implicitly decided that it doesn’t seem like a good idea to cast stones at the governance of corporate America. Nowhere was that fact made more obvious than in the fund industry’s almost unanimous opposition to the SEC’s proposal that we disclose to our own shareholders how we vote the proxies of the companies they own via our portfolios. While it would seem utterly obvious that a fund manager (the agent) would be expected to report his actions to the fund owners (the principals), the industry fought the proposal.

Total Returns on Stocks, Past and Future 4.5% 3.4% 2.0% 5.0% 6.4% 6.0% -1.0% 2.7% 0.1% -2% 0% 2% 4% 6% 8% 10% 12% 14% Last 100 Years Last 25 Years Next 10 Years 9.6% 12.5% 7.0% Earnings Growth Dividends P/E Change Investment Return Speculative Return 4. Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient. Harvard Business School Professor Rakesh Khurana was right when he defined the standard of conduct for a true professional with these words: “I will create value for society, rather than extract it.” And yet money management, by definition, extracts value from the returns earned by our business enterprises. Warren Buffett’s wise partner Charlie Munger lays it on the line: “Most money-making activity contains profoundly antisocial effects . . . As high- cost modalities become ever more popular . . . the activity exacerbates the current harmful trend in which ever more of the nation’s ethical young brainpower is attracted into lucrative money-management and its attendant modern frictions, as distinguished from work providing much more value to others.” Yet even as I write these remarks, I read that this brainpower is pouring into financial services at the most breath-taking rate in history.

CDOs are but one example of the exploding market for financial derivatives. As recently as 1960, for example, derivatives on the S&P 500 Index—futures and options in essence, speculation on the future price of the Index, either to take on huge risk exposure or to hedge against market declines—did not even exist. Today, an estimated $23 trillion of these futures and options are outstanding, compared to the $13 trillion actual market value of the 500 Index itself. The “speculation market,” then, is almost double the value of the “investment market.” However striking that relationship, these derivatives are a mere drop in the bucket of the global total of some $500 trillion in financial derivatives of all types; as a point of reference, the gross domestic product (GDP) of the entire world is about $50 trillion, a mere one-tenth of the derivative total. A few years ago, Warren Buffett described derivatives as “financial weapons of mass destruction,” while Alan Greenspan applauded their benefit, noting that “the prudent use of derivatives help banks to reduce risk.” Today it seems clear that it was Buffett who got it right. While innovations such as derivatives have enriched the financial sector (and the rating agencies) with enormous fees, these over-rated, as it were, CDOs have wreaked havoc on the balance sheets of those who purchased them, and held them, including the banks and brokers themselves. What is more (if we need more!)

Earnings Management and Executive Compensation Second, as the market’s focus moved from earnings to earnings growth, corporations began to report earnings that lost touch with reality. In what I have called a “happy conspiracy” among corporate managers, public accountants, Wall Street analysts, investment bankers, and Old Economy vs.24%

at a ratio of 1.25%. I’m going to sketch out very roughly (there is no reliable industry data) where that 97 basis advantage point is derived:  About 45 basis points, very roughly speaking, is derived from the fact that under our mutual structure, we operate on an at-cost basis for our fund investors, while our competition operates at a pre-tax profit margin estimated at 40% to the fund managers.  Another 25 basis points reflects the enormous marketing expenditures of our peers, compared to our nominal efforts. (Why spend the shareholders’ assets on a function that provides no value to them?)  We probably pick up another 15 basis points by managing 70% of our assets internally, and by vigorously negotiating the fees we pay to our external advisers, while our peers negotiate fees with themselves (that situation, in Warren Buffett’s words, “seldom produces a barroom brawl”).  The remaining 12 basis points comes from administration, reflecting some combination of the economies of scale that go hand-in-hand with our giant size, and the sheer cheapness that underlies our low-cost philosophy Voila! A staggering 97 basis point cost advantage—one, as I have noted, that truly matters in the results we deliver to investors (Chart 8). The resulting $5 billion that our shareholders save annually reflects a cost advantage so stupifeyingly large that we have the flexibility to spend as we must in order to provide top-quality services to our shareholders.

entrepreneur must be able to give his creations—his gems of vision—the force of hard work so that they might last and be noticed.” In the context of Schumpeter’s three standards of entrepreneurship—the dream of a kingdom; the will to conquer and the impulse to fight for success, primarly for its own sake; the joy of creating and exercising energy and ingenuity—the paper concludes that I qualify. While I warned him that “I do not have a great mind,” he credits me with something that may be a good substitute: the gift of “making the obscure seem obvious and the opaque transparent.” He goes on to observe that a gift for spreading the word over the years in speeches to the Vanguard crew, to industry gatherings, to the press, and to the public, combined with a certain energy and determination, have served me well, in my passionate mission—my dream, my will, my joy (to whatever degree the myth is accurate)—to create a better world for mutual fund investors. A Slice of the World in Context In his one interview with me, I described Vanguard’s success as “importantly derived from an uncanny ability to recognize the obvious.” And I think, honestly, that’s all I’ve done. He credits that gift as arising from a naturally curious mind combined with a liberal education, facilitating an understanding of the nature and context of a business, and putting his own slice of the world in context.

We all know what quality is in this business: accuracy, timeliness, responsiveness, problem resolution, presentation, simplicity, courtesy, professionalism, empathy, are some of the words that come to mind. In this day and age, investor expectations of quality service are staggering, and the number of different ways that different individuals want different accounts in different funds handled is almost beyond belief. But in a shareholder-owned organization like Vanguard, our investors are entitled to have their expectations not merely met, but exceeded. In a world where the desideratum is “treat your customer like an owner,” an organization in which the client actually is the owner is king. “Penny Wise and Pound Foolish”?

Suffice it to say, I’m dedicating 100% of the dollars in my deferred compensation program, much of which has compounded tax-free over the years, and is not of inconsequential value, to charities and foundations. My children know of this plan, and are kind enough to endorse it. They know that they are hardly forgotten in my estate planning, in which I’ve followed the Warren Buffett rule: Leave your children enough money so they can do anything they want to do, but not so much they can do nothing. The Rochester United Way Endowment I’d like to take a moment to salute the citizens of Rochester for helping the United Way here to build the largest community endowment of any region in America—more than $100 million. (Our Philadelphia United Way endowment is approaching $40 million, but we’re working on it!) One of the wonderful by-products of your endowment fund is that it generates enough income to pay 100% of the annual operating expenses of your United Way campaign and staff. The net result is that, from a cost-effectiveness standpoint, the reported operating expenses of your fund-raising efforts are nil: 100% of every dollar you give to the campaign flows directly through to the worthy beneficiaries in your community.

From its lowly beginning in 1948 with my struggle to absorb his Economics textbook, my association with Paul Samuelson had a wonderful turnaround. While I had hinted at the merit of an index fund in my Princeton thesis (mutual funds “can make no claim to superiority over the market averages”), I ignored that important finding for years. But in mid-1975, I decided that the time was ripe for the world’s first index fund, importantly because of Paul Samuelson’s inspiration. That inspiration came when I read his lead essay in the inaugural edition of The Journal of Portfolio Management (Fall 1974). In his essay, “Challenge to Judgment,” Dr. Samuelson explicitly called for those who disagreed that a passive index would outperform most active managers to produce “brute evidence to the contrary.” (None was forthcoming.) He pleaded “that, at the least, some large foundation set up an in-house portfolio that tracks the S&P 500 Index—for the purpose of setting up a naïve model against which their in-house gunslingers can measure their prowess.” Confronted with his express challenge for somebody, somewhere to start an index fund, I could no longer stand back. It now seemed clear that the newly-formed Vanguard Group (then only a few months old) ought to be “in the vanguard” of this new and logical concept, so strongly supported by the data on past fund performance, and so well accepted in academia but so little acknowledged by fund industry leaders.

Carefully and regularly evaluate whether your transaction activity has enhanced or detracted from the returns you have realized for your clients. 6. Taxes are the largest single detractor from Embedded Alpha. If your clients are taxable, evaluate your managers on after-tax returns and use after-tax returns as the basis for incentives. If you have both taxable and tax-deferred accounts, offer separate funds for each. 7. Eliminate opportunity cost. Cash, to be sure, is fine when raised just before a market decline. But you know as well as I that there’s simply no evidence of firms that have been successful at market timing. Thus, the return-enhancing characteristic of cash in down markets is inevitably a small fraction of its return- reducing characteristic in the rising markets that are far more common. 8. (For mutual funds only.) Get rid of 12b-1 fees, those sales commissions that are built into expense ratios. They make your reported returns look terrible; they usually entail heavier costs to the investors you serve; and simply, by being hidden, they raise serious questions about your candor and integrity. While together these steps will change the nature of institutional investing, given the influence of Embedded Alpha on long-term returns, I believe it is only a matter of time before clients will demand change. Forewarned is forearmed.

The diamond represented by the doctors and nurses, my guardian angels at Hahneman Hospital, and the anonymous donor—and his family—of the heart that beats in my body tonight. I received it on February 21, 1996, only weeks or perhaps months before my own tired heart would have expired. I have received more blessings—surely more “acres of diamonds” right here in greater Philadelphia—than any other human being on the face of this earth. And the blessing you have brought to me with this Award for Excellence in Leadership tonight is one more blessing that I shall treasure always. From the bottom of my new heart, I thank you, one and all.

How would such a firm make money on a fund that generated no advisory fees and no sales commissions, a fund in which virtually the entire investment return goes to its shareholders? While every firm in our industry had the opportunity to invent the index fund, like the prime suspect in a murder investigation, only Vanguard had both the opportunity and the motive. I cannot tell you exactly how many modern-day investors have enjoyed the warm comfort provided by the remarkably efficient index mutual fund, but it may well be far less than the proportion of homeowners who were warmed by the efficient Franklin stove all those years ago. Nor can I assure you that the widely-diversified index fund has protected more investors from losses from the lightning bolts that have struck some widely ballyhooed individual stocks, causing them to become, well, toast, than the proportion of the Colonial citizenry protected by Dr. Franklin’s lightning rod. But I can tell you that in the 25 years since the Vanguard 500 Index Fund was invented, it has outpaced the annual return of the average stock fund by an estimated two percentage points.million,

” Among 690(!) ETFs today, 678 are narrowly focused, some on individual foreign countries (Korea, Germany, whatever you wish) or industry sectors (technology, small-caps, even most recently, HealthShares Emerging Cancer). Only 12 of the 690 ETFs are highly diversified index funds holding the entire U.S. stock market or the entire non-U.S. stock market, close cousins to our diversified blue-chip funds of yore. Of course such ETFs, held for the long term, are perfectly fine investments. But actively pursuing these popular narrow strategies that drive the ETF business, too often chasing past performance, will surely be hazardous to the wealth of our investors and in the long-run, that can’t be good for our industry. All things considered, the burgeoning growth of ETFs is a dream come true for fund managers, industry entrepreneurs, financial advisers, and brokers. They offer the excitement of a new idea, massive publicity, and the marketing flexibility of the fund industry’s asset gatherers to focus on whatever sectors are hot and whatever strategies have paid off in the recent past, all the better to attract the capital of performance-hungry investors. But is it too much to ask whether these index funds nouveau are an investor’s dream come true? I don’t think that they are. Indeed, in a real sense, the ETF is a trader to the cause of classic indexing.investment

I go quickly to the first principle: The stock market is not an actuarial table. Yet the projections provided in the numerous websites that investors can access seem to me to cast an aura of predictability—if not certainty, surely high relative assurance—in the numbers that appear. But the output, as ever, is highly sensitive to the input. A few examples from three different websites make the point.  Consider a retirement plan for a 30-year old investor, investing 6% of his $50,000 salary in a 401(k) plan (with a 3% company match), his income growing at 5% per year until planned retirement at age 65. If he believes the stock market’s annual return will be 12%, in 2060 (when he will reach his actuarial life expectancy of 90 years) the accumulated capital would be $22,848,149. (Note the precision!) If, on the other hand, the market return turns out to be 9%, he runs out of money at age 81—a zero balance, and nine years too soon at that.of

broaden the issues that may be raised by owners in corporate proxies without running afoul of the “ordinary business” exclusion. No, shareholders aren’t there to tell a corporation how to run its business. But they have a right to a fair process in which they can tell a corporation to do a better job. If these changes sound to you like a call for anarchy, consider that unless a majority of shares were voted in favor of the change, nothing would happen. (Indeed, even if an overwhelmingly favorable vote is obtained, companies can—and do!—ignore it, since shareholder votes are non-binding. Under state law, votes are “precatory,” a word I have come to detest. Surely we need rules that return these rights to shareholders.) Doesn’t the whole underpinning of our capitalistic system depend upon the notion that the will of shareholders shall be done? But owners don’t need to remain asleep at the switch until changes are at last put into place. Even today, owners can make their will felt in other, more subtle, ways too. If they’re not satisfied with a company’s leadership, they can withhold votes from directors who are CEOs. (In less than a week we’ll see how they feel about Michael Eisner’s record at Disney Company. While the company’s earnings have been flat for about a decade, his aggregate compensation of nearly $1 billion(!) represents a shocking raid on the company’s treasury. To its credit, ISS is recommending that institutions withhold their votes for him.)

what we have learned from long years of experience: that a top-performing fund can not be selected in advance. While we may know history’s appraisal of the equity premium in the past, we never can be certain of what will be the equity premium that will prevail in the future. So, let’s consider the implications of two future environments, one bearish, the other bullish: (1) an equity return of 7% and a risk premium of 1%; and (2) an equity return of 12% and a risk premium of 4%. In the former case, the low-cost stock fund consumes 20% of the 1% risk premium compared to 220%(!) for the high-cost fund—and please recall that fully 25% of funds in the industry have costs in that range. In the latter case, costs of the low-cost fund would consume 5% of the 4% risk premium, the high-cost fund would consume 55%. This example contrasts the returns achieved by the three portfolios at various asset allocations: Exhibit IX Gross Gross Annual Return Equity Annual Return Equity Stocks Bonds Premium Stocks Bonds Premium 7% 6% 1% 12% 8% 4% Allocation Fund Return Fund Return Stocks Bonds High Cost Avg. Cost Low Cost High Cost Avg. Cost Low Cost 80% 20% 5.0% 5.6% 6.6% 9.4% 10.0% 11.0% 70 30 5.2 5.7 6.6 9.3 9.8 10.7 60 40 5.3 5.7 6.5 9.1 9.5 10.3 50 50 5.4 5.8 6.4 8.9 9.3 9.9 40 60 5.5 5.8 6.3 8.7 9.0 9.5 30 70 5.6 5.9 6.2 8.5 8.8 9.1 20 80 5.8 5.9 6.2 8.4 8.5 8.8 Note: High-cost fund: 2.2% Average-cost fund: 1.5% Low-cost fund: 0.

They should be measured against the market segment (or segments) in which they choose to participate. Weighted indexes combining appropriate levels of large cap and small cap, value and growth, and international surely make sense. That said, however, blame the client if he selects a small-cap strategy and the adviser outperforms the small-cap universe yet fails to outpace the total market over the long term. But blame the adviser if he overweights small-cap in the hope of beating the total market over the long term but fails to do so. Further, consider the role of bonds and cash reserves in the asset mix of the target index. Stock indexes (and index funds), to state the obvious, hold neither. A balanced fund should be measured against a balanced mix of stocks, bonds, and reserves. And it would not necessarily be foolish for an adviser to an equity fund which holds a fairly consistent 5% to 15% position in cash reserves to use a similarly adjusted stock/reserve benchmark.dampen

Pillar 7. The Powerful Magnetism of the Mean In the world of investing, the mean is a powerful magnet that pulls financial market returns toward it, causing returns to deteriorate after they exceed historical norms by substantial margins and to improve after they fall short. Reversion to the mean is a manifestation of the immutable law of averages that prevails, sooner or later, in the financial jungle. In the boom-and-bust bubble we have just witnessed in the NASDAQ Index, we have a wonderful example of reversion to the mean (RTM). After closely tracking the NYSE Index of all listed stocks from the mid-1970s through the end of 1997, the unlisted stocks in the NASDAQ Index took off in 1998, rising 230% (!) though the first quarter of 2000, eleven times the 20% gain in the NYSE Index. Then, reversion to the mean promptly wreaked its havoc, and with a vengeance. Since then, the NASDAQ has tumbled 67%, compared to a loss of but 7% for the NYSE Index. At the high last March, a dollar invested in NASDAQ Index in 1972 had soared to $1.80 for each dollar in the NYSE Index. But it has now fallen to just 58 cents. RTM strikes again, and, I’m confident, not for the last time. $0 $10 $20 $30 $40 $50 $60 $70 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2000 NYSE Nasdaq 7. The Powerful Magnetism of the Mean $58.42 $32.33 $32.60 $18.99 Growth of $1

Myth #4. Mutual Fund Costs are Declining Back in 1950, when I was writing my thesis, the expense ratio of the average equity fund was 0.77%. It has been rising ever since, hitting 0.96% in 1980, 1.20% in 1987, leveling off at about 1.40% through 1995, and then, with the rapid formation of new—and higher-cost, always higher-cost—funds, rising to 1.58% last year. In all, the expense ratio of the average equity fund has risen by more than 100%—a doubling of unit costs. Yet, sparked by heavily-publicized industry data, a myth that fund costs are actually declining has developed. Specifically, one industry study says, using a thoroughly inaccurate formulation, that the “costs of fund ownership” are declining. What it meant to say is that the costs of purchasing funds is declining. The industry study concedes that the average unit cost of equity funds is now 1.93% (35% higher than even my 1.58% figure). But it alleges that the average cost of purchasing equity funds—when weighted by each fund’s sales volume—has declined from 2.26% in 1980 to 1.35% in 1998. The study leaves, dare I say, much to be desired. Loading the dice by making sales volume the basis of cost measurement, the study merely captures the remarkable shift in investor choice from high-cost funds to a relative handful of no-load funds, low-expense-ratio funds, and minimal-cost index funds. But price competition is defined, not by the actions of consumers, but by the actions of producers.

In the era that lies ahead, the trusted businessman, the prudent fiduciary, and the honest steward must again be the paradigms of our great American enterprises. It won’t be easy, but if we all work long enough and hard enough at the task, we can build, out of a long-gone ownership society and a failed agency society, a fiduciary society in which the citizen-investors of America will at last receive the fair shake they have always deserved from our corporations, our investment system, and our mutual fund industry. Capitalism and Values The idea that values should be intimately embedded in the practice of business, of course, was an important message of my idealistic Princeton thesis of 54 years ago. But I’m hardly alone.greatest

For it is not at all clear the SMAs (separately-managed accounts) have significant advantages over mutual funds:  First of all, while fund costs may be our Achilles heel, the costs of the SMA are even higher: 2% to 3% per year (plus transaction costs) is the going rate. Fee-based compensation, the Forrester report asserts, could raise payouts to brokers by 50%, and it is the client who will bear these costs.  Second, the tax-efficiency benefit is dubious. Who says that SMA’s necessarily provide greater efficiency? And even if it exists, won’t the value of such a benefit be far lower in an era of subdued equity returns. (Today, equity funds as a group may well have unrealized losses on their books.) Further, taxes are not a particular issue for bond and money market funds— now 40% of industry assets—and some one-half of all equity fund assets are in tax-deferred plans. Finally, regular index funds and tax-managed mutual funds offer readily available tax relief.  Third, I don’t believe that SMAs offer investment advantages, and they may be disadvantageous to investors. There is no arguing against the notion that the essential mission of the investor is to capture as close as possible to 100% of the returns provided by the financial markets in which they invest.by

70 basis points and turnover cost about 30 basis points lower). I hardly need note that an advantage of a full percentage point in the bond market—easily explained, achieved without extra risk, and virtually certain—is the functional equivalent of a license to steal for the bond fund investor. And that saving adds up. A $1 million investment in the bond index fund would have grown to $3.13 million from 1986 through October 2001, compared to $2.73 million for the average bond fund—a $400,000 advantage that comes not by mathematical legerdemain but simply by shifting the allocation of the returns generated in the bond market from the fund managers to the fund owners. From the croupiers to the gamblers, if you will. While the returns of bond funds are less diffuse than the returns of stock funds, the bond group nonetheless includes a diverse array of maturity and quality classes, meaning that comparisons of bond funds as a group with an index of the total bond market is not always representative of reality. Further, many investors don’t seek to own “the bond market.” Rather, they may prefer to commit to its short-term or intermediate-term or long-term segment. For this reason, back in the winter of 1994, we also formed the first (and, inexplicably, still the only) series of defined-maturity bond index funds. When compared with their peers following similar policies, they show the same magnitude of advantage.

, related “specialized investment vehicles (SIVs) have also created havoc. To sell these instruments, our giant banks increasingly issued “liquidity puts” to buyers, guaranteeing to repurchase them on demand at face value. Citigroup, it turns out, was not only holding $55 billion of CDOs on its books, but also some $25 billion of SIVs that have been “put” back to the bank, a fact not publicly disclosed by Citi until last November. Astonishingly, former Treasury Secretary Robert Rubin, chairman of Citi’s Executive Committee (and a man, one might say, of not inconsiderable financial acumen) has stated that until last summer he had never even heard of liquidity puts. (Not quite as embarrassing as former chairman Charles Prince’s earlier comment: “As long as the music is playing you have to keep dancing. We’re still dancing.”) The peculiar characteristics of financial innovation are not limited to fixed-income investments underwritten by our investment banks. The mutual fund sector too has much to answer for. For example, in the late 1990s, innovation in the mutual fund sector was designed to capitalize on the so-called “New Economy.investors

In the fund arena then, just as costs matter, so taxes matter. A Good Solution: The Index Fund At this point, you are probably thinking either (a) that you should just forget about mutual funds for taxable accounts, or (b) that there must be a better way for them to achieve the valuable diversification that mutual funds clearly provide. Well, there is a better way, through which you can avoid suffering the negative consequences of both high costs and excessive taxes, and come as close as the law of the financial markets allows to achieving a positive Alpha. For there are a relative handful of funds that operate at a minimal cost and with a minimal tax burden. Most are market index funds, usually owning all of the stocks in a given arena (i.e., the Standard & Poor's 500 Stock Index, composed of large cap stocks that represent 70% of the value of the total market) or in a few cases the entire stock market (the Wilshire 5000 Equity Index). And they are working well, especially the latter, since significant changes to its composition simply do not take place. Let's begin with a baseline: the after-tax return of the Standard & Poor's 500 Stock Index. We'll deduct income tax from the dividends, and assume no capital gain realization, deferring all capital gains taxes. With a pre-tax return of 16.7% over the past 15 years and an estimated tax impact of -1.6% (largely because of income taxes), it produces an after-tax return of 15.1 %.

But in this opening skirmish in the battle to at long last return this industry to the role it must play in restoring owners capitalism in corporate America, if the industry lost, the shareholders won. The Curious Paradox The task of returning the mutual fund industry—and indeed institutional investing in general—to its traditional focus on long-term investing and good corporate citizenship will be no mean task. It is a curious paradox that the increasing problems created by managers capitalism in mutual funds has, by making funds reluctant to assume their responsibilities of corporate citizenship, been a major force in the rise of managers capitalism in corporate America. For as I noted at the outset of my remarks, when no responsible owner exists, capitalism itself is corrupted. The legendary Benjamin Graham long ago put his finger on the problem. In the early editions of The Intelligent Investor, he had some important things to say about stockholder- management relationships.king

individual and institutional stock owners alike, market participants developed a vested interest in promulgating aggressive earnings expectations, and a survivor’s interest in measuring up to them, quarter after quarter. The flexibility of the day’s accounting standards turned earnings management into what could be called “metrics fraud,” with the publication—and acceptance by a greedy marketplace—of so-called “pro-forma earnings” or “core operating earnings.” What did those managed earnings mean? As the Mad Hatter told Alice, they mean “exactly what I say they mean.” And even traditionally conservative corporations came to play such games as booking investment gains into earnings, financing purchases made by customers, under-depreciation, counting revenues from goods not yet delivered, and securitization of receivables. The liberal use of these dubious accounting procedures, often required simply to meet the so-called “earnings guidance” targets provided to the financial community made, well, everybody (except the short- sellers!) happy in the short-run, but had the worst possible effect over time. For the aggressive management of earnings undermines the confidence of investors in the integrity of corporate financial statements. Alas, financial integrity is a lot easier to lose than to reclaim. Third, led by the young technology companies, the compensation structure of American business changed.

Consider Morningstar Mutual Funds, which provides “everything you ever wanted to know about your fund, but were afraid to ask,” and on a single page at that: Historical asset values and dividends; total returns on a quarterly basis, absolute and relative to market indexes and peers; fund expense ratios and sales charges; tax efficiency; risk analysis; the 25 largest stock holdings; the average price-earnings ratio, earnings growth rate, and market capitalization; industry weightings; and, if you’re into Modern Portfolio Theory, alphas, betas, and R-squareds. And there’s still room left on the page for a two-paragraph editorial comment! All topped-off by the fund’s rating: one-star, worst; five-star, best. I fear, however, that fund investors pay little attention to this plethora of information on fund risks, costs, and portfolio construction. Rather, they select funds that have had hot past performance and five-star ratings. But since past performance has rarely proven prologue to the future, “stars” cannot—and do not—give investors the power to select future winners.A

First, the dividend yield was a known quantity. It had fallen to an all-time low of 1.1%, eliminating it as a major driver of future investment return, and leaving the heavy lifting to earnings growth. I picked 6% as a reasonable expectation for the coming decade, a bit above the trend line. If so, investment return in the decade ahead would have come to 7.1%. Chart – Past Stock Returns, and a Look to the Future What about speculative return? Over the previous two decades, the market's p/e ratio soared from seven times to 30.5 times, producing a 7.5% annual rate. With a p/e more than double the century-long norm, even if one naively believed that "this time is different," and that such a stratospheric ratio wouldn't decline, even if it held, the future speculative return would be zero. But my guess was that the p/e ratio might drop to the neighborhood of 18 times, providing a negative speculative return of about 5% per year. Result: An expected average return on stocks in 1999–2009 of less than just 2% per year—and not ten individual years at 2%; stock markets just don't behave that way. More likely, I said, was a 40% or 50% drop over a few years, followed by a return to more normal returns, say in the range of 9% annually. I've often said, "while we may know what will happen in the market, we never know when." But in an April 6, 2000 speech, I threw caution to the winds: "So let me be clear.have

Researchers found that the rate of ovarian cancer was not significantly different between those who did and did not use talcum powder. The study concluded that the rate of ovarian cancer amongst those who used talcum powder was 61 cases per 100,000 people per year, compared to 55 cases for those who have never used it. Therefore, the current scientific evidence would imply that J&J did not falsely advertise the safety of its Baby Powder, as there is no evidence of asbestos in its talcum powder and talcum powder itself has not been found to cause cancer. An important lesson from this example is that negative impacts are never clear-cut and the devil is in the detail. This is especially true when assessing the extent of a company’s responsibility for a negative impact. The headlines can sometimes give the wrong impression of a company’s guilt or exaggerate the degree of control a company has. This is why we don’t automatically exclude any company that has a RepRisk Indicator score above a certain level and why any assessment of a company with a high RRI needs to look at the details. This example also raises the question that if talcum powder did cause cancer, as investors, what should our stance be toward corporate responsibility in the face of questionable scientific evidence? Clearly, corporations should follow regulations. They should do due diligence in ensuring their products are safe and effective.

But it’s hard to imagine that few, if any, of you couldn’t be better stewards of the assets shareholders have entrusted to your care if you operated under a more enlightened governance structure. When fund directors examine the apportionment of fund returns between managers and shareholders; when directors consider the baneful trends that have developed in investment activity and fund costs; when the bright spotlight of public attention is focused on directors’ fees that seem grossly disproportionate to the responsibilities assumed and the time commitments involved; when board leadership devolves to independent directors served by independent counsel; and when the watchdog has no master but the investors that he or she is duty bound to serve; then, whenever trouble is afoot, we shall hear that barking dog, the strong watchdog that will lead the way in giving the fund investor a fair shake.

7% on stocks during this one-and-one quarter century period, a remarkable tribute to the long run rationality of the financial markets. In the shorter run, to be sure, there is a lot of irrationality. (In particular, it seems apparent today.) Stock market irrationality can be measured by the ephemeral—but critical—factor of the price that investors are willing to pay for $1 of corporate earnings, the widely known price-to-earnings ratio. If, following Lord Keynes, we use the term investment to describe the fundamental return based on earnings and dividends, we use the term speculation to describe this second determinant of stock prices: the price that investors will pay for each dollar of earnings. If the power of fundamentals dominates market returns in the very long run—as it clearly does—the power of speculation dominates market returns in the shorter run. (Speculation, indeed, may be the only reason for the sometimes astonishing daily, weekly, or even monthly swings we witness.) Over time, investors have been willing to pay an average of about $14 for each $1 of earnings. But if, in their optimism, they are willing to pay $21, stock prices will leap by 50% for that reason alone. If, in their pessimism, they are willing to pay only $7, stock prices will fall by 50%. The changing price of $1 of earnings creates powerful leverage indeed— but it doesn’t last forever. 3 I am indebted to Jeremy J.

Those frictional costs, the study suggests, constitute a dead-weight burden that detracts from the return that can be theoretically produced by an investment portfolio in a frictionless securities market. So firms are urged to “cut those hidden costs,” including: 1. “Tangible Costs . . . management fees and trading commissions. Each dollar given away for, say, management fees is a dollar explicitly detracted from the portfolio net return. 2. “Managed Costs . . . unintended risk exposures, tax costs, and Not-Equitized-Cash, an opportunity cost for not keeping funds fully invested. 3. “Invisible Cost . . . the adverse market impact of trading and the opportunity cost of delaying trade execution.” Result: “Simply put, every incremental basis point increase in rate of return translates into competitive advantage (by which) a firm improves its absolute performance and its ranking relative to its peers.” In the study’s words, the firm that “will lead the way . . .minimize

Today, the number CFAs (Chartered Financial Analysts) is at a record high of 78,000, and Barron’s recently reported that “no fewer than 140,000 new applicants—also a record high—from every corner of the earth are queued up to take the exams that will confer on the lucky ones the coveted (CFA) imprimatur.” In one sense this explosion is wonderful, suggesting that our professional designation is highly-valued. But it also raises serious concerns that the field will get more and more crowded, causing the costs of financial intermediation will to rise to even higher levels.

After all, in a given decade, about one of every five actively managed funds has outpaced the total market index (after taxes, only one of nine). These are powerful, but not insurmountable odds. And there are some simple common sense principles that should help you to select funds that can earn a generous portion of the market's return, although, all too likely, less than IOO%-and maybe a lot less. If there are long odds against outpacing the market, at least going about the task of fund selection intelligently can help to ensure against a significant failure. Even master investor Warren Buffett, a strong proponent of the index approach, concedes that there may be other ways to construct an investment portfolio: Most investors, both institutional and individual will find that the best way to own common stocks is through an index fund that charges minimal fees.

Perhaps they earn our respect because they do their good work as members of professions, putting the interests of their constituencies—and even the interests of society—ahead of their own self- interest, and knowing that accumulating great financial wealth in their endeavors is almost out of the question, that national or worldwide fame is rare, and that power—at least temporal power— is conspicuous by its absence. But don’t stop there. Let’s think too about the humble folk of this life who do the world’s work—farmers and carpenters, soldiers and firemen, plumbers and mechanics, computer programmers and train conductors, pilots and navigators, landscapers and stone masons, all of those who help us to live our lives in comfort. You know them. People who get up with the sun and do an honest day’s work, usually with neither complaint nor hope of accolade; souls who are rarely rewarded with those elusive fruits of so-called success. Yet surely few of them need worry about whether the rabbit they chase is real. Of course it is.

When we put them all together, the comparison of the actual results of the average fund with the results of simply owning a market index is truly a revelation, albeit one that is virtually—if understandably— ignored by the mutual fund industry. So, here are the results: Over the past 15 years, the average pre-tax return of the total U.S. stock market was 16.4% per year. But after the costs of all of the croupiers—fund sellers, fund managers, stock brokers, and the Federal Government—the return for the average fund investor was just 10.2% per year. By way of contrast, a low cost, no-load, low turnover all-market index fund would have provided an annual rate of return of 15.2% to the investor—fully 50% higher. And as both returns and costs compound, the difference widens. The value of an initial $10,000 investment at the end of the period: managed equity fund, $43,000; index fund, $83,300. In short, in search of the perfect plan, the investor in the equity fund relinquished 56% of the market’s gain to the croupiers, with but 46% left for himself. On the other hand, by holding the croupiers’ share to 14% of the market’s cumulative return, the investor who relied on the good plan of a market index fund retained 86%. His $73,000 profit was more than double the $33,000 profit of the regular investor. The point of this chart is not to attempt to persuade you to abandon the active management strategy that you likely follow, much as I might wish to do that.the

” You now know enough about Vanguard, I hope, to decide for yourselves whether that’s accurate, and indeed to decide whether or not I am truly an entrepreneur as you understand the term. Given the writer’s challenge, let me conclude by putting this saga of my slice of the world in some sort of context. Times have changed since Vanguard began in 1974. A fairly consistent 30% annual growth rate has turned a tiny firm into a giant corporation. The original crew of 28 now totals 5800. The dream has become the reality. Clearly, if an entrepreneur is defined as a leader who turns an idea into an enterprise, the day of the entrepreneur at Vanguard has passed. The skills of the manager, not the leader, are—must be—in the driver’s seat. The creator, however, remains the spirit and the missionary, and the mission remains unchanged: a fair shake for fund shareholders. And that’s, I suppose, my story—so far.

Enter Vanguard Surely you can’t look at the array of numbers I’ve presented showing the shortfall of fund returns to the market without wondering why on earth the investing public doesn’t turn its back on mutual funds and simply buy the market. I wondered about that too. Indeed, a half-century ago, I wrote these words in my Princeton University senior thesis on The Economic Role of the Investment Company: Mutual funds “can make no claim to superiority over the market averages,” and mutual funds “should be managed in the most honest, efficient, and economical way possible.” Given those convictions, it was clear that efficiently buying the market averages at an economical cost would be a smart investment strategy. But how to do it? The idea festered in my mind over the ensuing 23 years. Suddenly the opportunity arose to take action. Here we move from the odyssey of the stock market and the odyssey of the mutual fund industry to the odyssey of Vanguard, an adventurous journey that has been fraught with challenges but punctuated by good fortune. After my graduation from Princeton, I joined fund pioneer Wellington Management Company, and was named to lead the firm in 1965. In 1966, I entered into an unwise merger with some star fund managers.market

While my projection was then seen as absurdly pessimistic, in fact it proved to be a bit too optimistic. Earnings growth was virtually identical to my 8 percent guess-timate, but the price/earnings multiple tumbled to 17 times, somewhat below my projection of 20 times. But in terms of Total Return, the forecast looks pretty good, with the market on track to produce about a total return of 4 percent per year during the decade ending in 2009—remarkably close to the 5 percent figure that I forecast seven years ago. So, emboldened by a combination of wisdom, common sense, luck, and yes, the relentless rules of humble arithmetic, let’s look ahead to the next ten years. I expect the bagel of investment return to be nicely positive, most likely in the range of eight percent per year; i.e., adding today’s dividend yield of a higher but still stingy two percent to what I’ll guess is earnings growth in the six percent range. (After all, corporate earnings grow at about the same nominal rate as our economy. What else is new?) As to speculative return, I think investors are a bit too optimistic, and therefore I look to slightly lower valuations—a doughnut not quite so sweet—perhaps lowering the Total Return on stocks to 7 percent per year. Will that forecast be as accurate as my previous guess? Only time will tell, but I am hardly alone among experienced investors who believe we are facing an era of subdued returns in the stock market.

So the trend that this tortuous methodology measures is hardly evidence of what is described as “vigorous price competition” in the fund industry. Indeed, since few, if any, fund groups have slashed their fees to take on the low-cost funds in the marketplace, price competition is hardly intense; it is barely alive. And the study has still more weaknesses. It completely ignores a huge cost of fund ownership, fund portfolio turnover. That would add 0.50% to 1.00%-plus to the putative 1.35% total. It amortizes sales loads based on 25-year old data, ignoring today’s infinitely shorter (and therefore far costlier) holding period. It ignores the opportunity cost that funds incur by their failure to be fully invested in stocks—another 0.60% cost. And it no longer even reports the fact, buried deep in the first of its two studies, that the average expense ratio of the lowest cost decile of funds has actually risen by 27% since 1980—from 0.71% to 0.90% in 1997—perhaps up 35- 40% if Vanguard were excluded. Even the lowest cost funds will not be denied their fee increases.two

portfolio of Morningstar five-star funds, for example, has provided far lower returns than the stock market itself, all the while carrying significantly higher risk. So while technology has enriched investors by giving them better information, but investors have impoverished their potential returns by using the information to make worse decisions. They are acting as shoppers rather than long-term shareholders, and we in the industry haven’t fulfilled our responsibility to educate investors as to what information matters and what doesn’t. The Book of Proverbs had it right: “Get wisdom, get insight.” In addition to public networks that provide information on fund returns, risks, costs, and portfolios, nearly all of the major fund families have built proprietary networks that provide their shareholders with timely, accurate, and complete information about their investment accounts. If you go to Vanguard’s website, for example, and check the value of your fund accounts—all of your family accounts are at a single site, and one click will get you there after you identify yourself—and you’ll see the value of your account at the close of the previous day, any changes you’ve made in your holdings, and your balance among stock funds, bond funds, and money market funds. You can check your purchase dates and your tax basis. You can also quickly learn about pending distributions of realized capital gains, as well as each fund’s unrealized gains or losses.

during the three-year-bubble surrounding the market’s peak in March 2000. In the great bear market that followed, the NASDAQ (“New Economy”) Index dropped nearly 80 percent, and the NYSE (“Old Economy”) Index fell by 33 percent. Was this innovation good for fund marketers? Clearly yes. Good for fund investors? Categorically no. It remains to be seen whether today’s hottest mutual fund idea, ETFs—index funds that “can be traded all day long, in real time”—will prove to be a blessing to fund investors, or a bane. The Age of Turbulence This “age of turbulence” in which we now live is the product of too many years of cheap credit, and of sharply deteriorating credit standards, as well “new” products like derivatives and product packaging—like securitizing mortgages—in which its lenders off-load their loans to investors. Our highly-leveraged commercial banks and investment banks failed to consider the extraordinary risks of the securities they were creating and marketing, and earned billions in fees and commissions, even as they were left with tens of billions of dollars—even hundreds of billions—on their own balance sheets. The key question today is the extent to which these problems in our financial system will infect our U.S. economic system and our global systems as well.

interests of others, the love of what is honorable and noble, the grandeur and dignity of our own characters.” Adam Smith, here, the apostle of virtue, is advising us to put the greater interest of others before the interest of ourselves, and our failure to do so is reflected in modern-day managers’ capitalism in which the interests of those who run our corporations and financial institutions are ascendant. My Battle book is replete with scores of specific recommendations to help us return to our roots, the most sweeping of which is the call for the formation of a federal commission to (a) recommend policies that respond to the failure of our agency society in which direct stockowners have become an endangered species, and (b) to take the steps necessary to ultimately eliminate the frightening shortfalls—recently estimated at $1.2 trillion for pension plans alone—in the expected future wealth that investors will accumulate through the vastly underfunded retirement plan system that is the foundation of our national savings. These two problems are directly related, and best solved by the creation of a fiduciary society in which intermediaries truly represent—first, last, and only—the interests of those they serve. So, I recommend this federal approach for the development of an investor-oriented—not manager-oriented—fiduciary society.

Owners can also withhold votes for individual directors serving compensation, nominating, and audit committees if they are not measuring up to their responsibilities. While these votes are not, in and of themselves, likely to directly result in change, if enough owners use the ballot box to express their disapproval, companies will have to pay heed. Sending a strong message will help! Owners can also use their franchise to vote against auditors who are also providing consulting services, or at least against those whose fees for consulting services constitute a disproportionate relationship to audit fees. And of course owners can, and I believe should, be more aggressive in rejecting option plans that involve cumulative dilution that is excessive. Truth told, even today, owners have untapped powers, and they ought to put them to use—now, in this 2004 proxy season.

those two outcomes—$22 million vs. pauperhood—is more likely, or can even imagine what the future return on stocks will be.  Consider an asset allocation plan that calls for an “ideal mix” for a risk-averse investor of 27% in bonds, 13% in foreign stocks, and 60% in large cap growth stocks—assuming future returns of 8.6%, 9.5% and 13.6%, respectively. (Again, note the precision.) Now bump the foreign return up to just 10.6% and reduce the other two returns by a single percentage point and—abracadabra!—the required foreign stock allocation rises from 13% to 45% of the portfolio; bonds drop to 10%, and growth stocks drop to 45%. Who, really, is fooling whom here?  Consider another financial planning website—and an extremely successful one at that— which does a fine job of presenting options that show the probabilities of reaching your planning goal by the use of various assumptions grounded in the dispersion of past returns in the financial markets. This approach makes sense, but the system errs by making what appear to be highly arbitrary projections of future performance for individual funds. It assumes, for example, that three particular funds will produce a range of nominal returns as follows: growth fund: 16.56% to 1.50%; value fund: 14.38% to 2.02%; and the total U.S. stock market: 15.35% to 2.34%. (Precision again.)

From the inception date of our funds, here are the annual returns, net of all costs: Short- Term Bond Index Fund, 7.1%; average short-term managed fund, 6.3%. Intermediate-Term Bond Index Fund, 8.4%; average intermediate-term managed fund 7.6%. Long-Term Bond Index Fund, 9.7%; average long-term bond fund, 8.4%.3 Seven years to be sure, is a fairly short period to test the efficiency of defined-maturity bond index funds. But the obvious reasons for the index 3 The average long-term active fund has a significantly lower maturity than the bond index, and accordingly earned an actual return of 7.5%. The 8.4% return represents the return adjusted upward to reflect its lower risk. The Wisdom of Bond Market Indexing Growth of $1,000,000: 1986 - Oct. 2001 $1.0 $2.0 $3.0 Bond Index Fund Avg. Bond Fund Millions $3.1 $2.7 Avg. Ann. Return: Bond Index: 8.0% Avg. Fund: 7.0%

Let me put some dollars-and-cents meat on the bones of these ratios to show you how much we have had to spend to handle our present growth, to invest for our future growth, and to maintain our cutting edge in service quality. Five years ago, our annual expenditures were about $480 million—$400 million for operations plus $80 million of fees to our external investment advisers. This year we will spend about $1.3 billion, some $1.150 billion for our own operations and $150 million in advisory fees. Our own budget, then, has risen by $750 million, nearly tripling in just five years—hardly a sign of being, as the old saw goes, “penny wise and pound foolish.” Much of this increase arises from providing services to 14 million shareholder accounts rather than six million. But it also reflects the huge increase required to maintain and enhance service quality, including heavy spending on technology, now approaching, in very rough terms, one-third of our budget. We have been blessed by having our average assets burgeon during this bull market period—rising from $150 billion to $485 billion—enabling us to support our efforts without impinging on our low expense ratio. Indeed, our weighted fund expense ratio, 28 basis points in 1999, has eased downward from 30 basis points in 1994. That two point decline, coming in a period in which the expense ratios of our major competitors have risen by 20 basis points (to 125), we are doing just fine.

Equity Returns Over the Coming Decade 2.0% 2.2% 2.5% 6.0% 2.3% -1.0% -2% 0% 2% 4% 6% 8% Earnings Growth Dividends P/E Impact Inflation Expenses Net Real Return Sources Uses 5. 7% 7% What’s more, those rising costs are all too likely to occur in an era of falling returns on equities. Briefly put, the 100-year return of 9 ½ percent annually on stocks included a 4 ½ percent dividend yield. (Chart 4) Today’s 1.8 percent yield represents a dead-weight loss of 2.7 percentage points in future investment returns. By the same token, the glorious 12 ½ percent return of the past 25 years included not only a 3.4 percent dividend yield, but an 1.7 percent annual speculative return, borne of a price-earnings return that rose from 9 times to 18 times—a double! The drop in yields, and the likelihood (in my view) that today’s price-earnings ratio of 18 will not only not redouble, but is apt to decline by a few points in the coming decade, means that we are likely to experience a future return on stocks of about 7 percent. Shamelessly, I persist in reducing that nominal annual return of 7 percent by the estimated 2.3 percent expected rate of inflation, slashing it to a real return of just 4.7 percent. (Chart 5) Annual mutual fund costs—sales loads, expense ratios, and hidden turnover costs— are now running at about 2.5 percent, reducing the humble real return of the average fund by more than half, to just 2.2 percent. 2.2 percent! (That may be a best-case scenario.

In the New Era environment, technology firms and established firms alike made enormous grants of stock options to their managers. In effect, management demanded a large share in the huge rewards created by soaring stock prices, never mind that corporate earnings—even managed earnings—lagged far behind. What is more, while options have an easily-measurable value, that value was not considered a compensation cost, further inflating these earnings (and giving rise to Warren Buffett’s question, “if options aren’t compensation, what are they?”). Now, as we reach toward the bottom of the bear market, the options game is being played in reverse: Options are being repriced (and some that have been exercised at high prices have even been retroactively cancelled), a great benefit to executives, at an equally great cost to the owners of the company. It’s high time we required that stock options be based on real corporate cash flows, and not on fickle stock prices. Who Profits?achieve

compared to $14 million for the average managed mutual fund, as chance would have it, the very same nine million dollar increment reflected in my statistical study of a quarter-century earlier. III. Virtue It turns out that entrepreneurship, mutuality, and invention have something in common: Virtue. While virtue is a word that tends to embarrass us today, it surely didn’t embarrass Dr. Franklin. In 1728 when he was but 22 years of age, he tells us that he, “conceived the bold and arduous project of arriving at moral perfection . . . I knew, or thought I knew, what was right and wrong, and I did not see why I might not always do the one or avoid the other.” The task, he tells us, was more difficult than he imagined, but he ultimately listed thirteen virtues along with their precepts, even placing them in rank order of importance. The first four were Temperance, Silence (“Speak not but what may benefit others or yourself”), Order, and Resolution (“Perform what you ought”). The next were Frugality, Industry (“Be always employ’d in something useful”), Sincerity, and Justice. Then Moderation (“Avoid extreams”), Cleanliness, and Tranquility (“Be not disturbed at trifles”). And finally Chastity (though here Franklin famously succumbed to temptation) and Humility (“Imitate Jesus and Socrates”).

owning the market through a low-cost index fund, we know next to nothing about the records of SMA Managers.  Fourth, the challenges of operating SMAs is substantial. Few registered advisers and brokers are satisfied with today’s (largely) APL technology. And while tomorrow’s technology will surely be better, it’s hard to imagine that it can ever be as economical as the simple pooling of accounts that has been the crux of mutual fund operational efficiency since the industry began. A New Mutual Fund Industry Nevertheless, if mutual funds fail to change, our dominance will come to an end. We hold no permanent monopoly on the good will of our owners; we must re-earn it every day. Fund managements can no longer bask in the warm noonday sun and continue to place their own needs ahead of the needs of their clients. During the great bull market, many firms that trod the wrong path prospered. Even where prudence, principles, and stewardship took a back seat to marketing, the money rolled in. Hundreds of new aggressive funds were formed and backed with more than a billion dollars of advertising. “We’ll focus on short-term rewards, momentum, and concept stocks,” was the implicit strategy, “and don’t worry about higher fees, and portfolio transaction costs.” In an era of exploding returns on stocks, the sky seemed to be the only limit to excess. Those strategies won’t play well in the years ahead. We must make speculation passé, and put stewardship in the driver’s seat.

professionals to stay the course with the proven strategy. While I can’t say that classic indexing is the best strategy ever devised, I can assure you that the number of strategies that are worse is infinite. Creating Indexes that Beat the Market. The New Paradigm? It is a curious irony that the ETF has been adopted as the format for the new “fundamental” indexes. This “new breed” of indexers—although they are not, in fact, indexers, but active strategists—focuses on weighting portfolios by so-called “fundamental” factors. Rather than weighting by market cap, they use a combination of factors such as corporate revenues, cash flows, profits, or dividends. (For example, the portfolio is weighted by the dollar amount of dividends distributed by each corporation, rather than the dollar amount of its market capitalization.) They argue, fairly enough, that in a cap-weighted portfolio, half of the stocks are overvalued to a greater or lesser extent, and half are undervalued. The traditional indexer responds: “Of course. But who really knows which half is which.” The new fundamental indexers unabashedly answer, “we do.” They claim to know which is which. And—this will not surprise you—the fundamental factors they have identified as the basis for their portfolio selections actually have outpaced the traditional indexes in the past. (We call this “data mining.

They are sure to beat the net results delivered by the great majority of investment professionals. Should you choose to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. The Prussian General Clausewitz has said, "the greatest enemy of a good plan is the dream of a perfect plan." And I believe that an index strategy is a good strategy-and a very good one at that. But many of you, I'm confident, seek a better plan, if not a perfect plan, no matter how great the challenge, no matter how overpowering the odds against implementing it with extraordinary success. So, much as I would not hesitate to urge you to commit your investments to an all-index-fund approach-or at least to follow an approach using index funds as the core of your portfolio--I'm going to offer you another simple approach-"a few thoughts worth remembering," eight basic rules to make it easier for you to make intelligent fund selections for your investment program. Here we go: Rule 1. Select Low-Cost Funds. I've said "costs matter" for so long that the portfolio manager for one of our funds gave me a Plexiglas pillar with the Latin translation: Pretium Refert. But costs do matter. If you don't believe me, hear Warren Buffett again: Seriously, costs matter. ...

Pillar 8. Do Not Overestimate Your Ability to Pick Superior Equity Mutual Funds, nor Underestimate Your Ability to Pick Superior Bond and Money Market Funds. In selecting equity funds, no analysis of the past, no matter how painstaking, assures future superiority. In general, you should settle for a solid mainstream equity fund in which the action of the stock market itself explains about 85% or more of the fund’s return, or an low-cost index fund (100% explained by the market). But do not approach the selection of bond and money market funds with the same skepticism. Selecting the better funds in these categories on the basis of their comparative costs holds remarkably favorable prospects for success. While I’ve shown you earlier the near-causal relationship between costs and returns among fixed-income funds, the futility of picking stock funds based on their past returns has seldom been more forcefully demonstrated than in the past two years. Among the twenty top-performing equity funds for the year ending March 31, 2000, 15 of the Top-20 tumbled to ranks ranging from #3453 to #3891 among 3896 funds during the year that followed. Only one fund even ranked higher than #1000. Picking equity funds on the basis of past performance is not a good idea!

these performance detractors.” Thus spaketh, I remind you, not Vanguard/BOGLE, but Merrill Lynch/BARRA. Perhaps surprisingly, the study presents no data whatsoever on the dimension of Embedded Alpha. So it won’t astonish you to learn that I’ve taken it upon myself to do exactly that, examining the mutual fund business and the costs that fund investors incur. The pictures: Average Equity Mutual Fund % of Average Assets 1. Advisory Fees 0.8% 2. Other Operating Expenses 0.5 Total Expense Ratio1 1.3% 3. Transaction Costs 0.7 4. Opportunity Cost 0.4 Total 2.4% You don’t need me to tell you that 240 basis points is a lot of Embedded Alpha. And I haven’t even taken into account the impact of fund sales charges and the heavy cost of taxes for non-retirement plan investors! Embedded alpha is admittedly lower for pension funds—its estimated at 1.3%—but it nonetheless takes a powerful toll there as well. Indeed, a recent study by a major pension consultant projected that even costs at the 1.3% level reduce the probability that a given active manager can beat the market over the long term at 5%—just one chance in twenty. The Long-Term Toll of Costs Now let’s look long-term. Despite today’s environment of frighteningly short-term investment horizons, most pension funds have seemingly perpetual lifetimes. And most individual investors now start their programs in an IRA or 401(k) at a young age, and will still be investing, not only 50, but even 70, years from now.

The S&P 500 Index You’ll note that I’ve used the S&P Index in my market measure for the past 50 years. While it was the only good standard available in 1950, it remains the most widely accepted standard and, most importantly, continues to provide an excellent if imperfect measure of the stock market. You may have heard—and even believed!—the apocryphal story about the bumble bee: After carefully examining its aerodynamics, weight, and size, an expert group of scientists proved beyond doubt that the bumblebee can’t fly. Yet fly it does. It occurs to me that a similar fable is applicable to the Standard & Poor’s 500 Stock Index. It doesn’t look like it should work, but it obviously does. One only has to consider a few anecdotal examples to understand why it can provide outstanding relative performance. Consider first the S&P 500 fifty years ago, then as now an index of large-cap stocks in a large-cap dominated market. (Well, not the S&P 500; it was the S&P 90 from 1926 through 1957.) In 1950, it represented a highly concentrated tribute to industrial America. Although I don’t recall anyone examining the composition of the index with the kind of attention lavished on it today, General Motors, its largest holding, represented 13.6% of its weight. Standard Oil of New Jersey was next at 9.3%, and the top ten holdings accounted for 51.3% of its weight, making it more than twice as concentrated as the 24% weight of the top ten today.

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.

If that 7 percent projection is correct, investors would be wise to do their best to capture it. That means low-cost, long-term investing—yes, just what an index fund does—that will guarantee you with your fair share of whatever returns our financial markets are generous enough to provide, the consummate winner’s game. And it means recognizing and accepting that high-cost, short-term speculation—with all of its trading costs, expensive management fees, and unnecessary taxes—is the consummate loser’s game. Despite the failure of our financial system, then, there is no reason you can’t avoid its myriad potholes, and by so doing be a winner. Wrapping Up As I look back over the institutions whose lives I’ve been privileged to touch, I confess to letting a little pride peep out—much as I’ve tried (in Benjamin Franklins pungent words) to “disguise it, beat it down, stifle it, mortify it as much as one pleases, pride will nonetheless every now and then peep out.” And so it does when I concede that I’ve likely left the National Constitution Center, Blair Academy, and Vanguard, to some degree at least, better than I found them. Alas, I cannot say that I’ve done the same in my against-all- odds fight to restore the mutual fund industry to its proud heritage, to build a better financial system for our nation, and to return capitalism to a more productive role in our society.

2% In sum, if you accept my premises and my forecast ranges (That may be a lot to ask!), you have some choices that seem fairly obvious. For example: In the case of the low-market-return, low-equity-premium scenario, an investor could chose a 100% bond portfolio and expect a higher return (6%) than in a portfolio of 100% high-cost-stock funds (5%). Turning to exhibit IV in the case of the high-market-return, high- equity-premium portfolio—an investor could chose a low-cost 50/50 stock/bond portfolio and expect a higher return (9.9%) than in a high-cost 80/20 stock/bond portfolio (9.4%)—that is to say with the equity exposure reduced by fully 30 percentage points.

crucial importance of minimizing the take of all of those croupiers out there. You must do so if your long-term accumulation of assets is to meet your financial requirements. Put another way, as you dream of developing the perfect plan for investing, learn all that you can from the good plan. Rule 6: Beware of Past Performance to Predict Future Performance For your dream of a perfect plan to be realized, you must select superior mutual funds. To an amazing extent, investors rely on past performance to make their selections. If you do so, I warn you, you are learning on a weak reed. There is simply no way of predicting a fund’s future success based on its past track record. Indeed, the one thing that appears certain about the future relative performance of successful funds is this: Performance superiority will not be sustained. For example, the top quartile of 40 funds beat the market by nearly 3 percentage points annually during the 1980s, only to lose by one percentage point during the 1990s—a reversion of 4.2 percentage points. And of these 40 top quartile funds during the 1980s, fully 39 funds had their margins over the market reduced in the 1990s, including 32 funds that provided returns below those of the market. This pattern is called “Reversion to the Mean,” a sort of law of gravity that seems to be almost universally applicable in the financial markets. It is not a statistical aberration.

. . they can hire and fire managements and bend them completely to their will.” He was—and is—right. But he was—and is—right when he added that “the assertion of rights by stockholders in practice is almost a complete washout. They show neither intelligence nor alertness unless prodded violently into action. They vote in sheep-like fashion for whatever management recommends and no matter how poor the record of accomplishment may be . . . this attitude of the financial world toward good and bad management is utterly childish.” Yet the cause is not lost. Even after all these years, perhaps Benjamin Graham’s words can awaken us, and force us to consider ways that institutional stockowners, working in concert with corporate managers, can root out the problems that plague our system. Here are four suggestions: 1. Encourage Corporate Citizenship. The only way investors—and particularly institutional investors—will become better owners is if we at last return to behaving as responsible corporate citizens, voting our proxies thoughtfully and communicating our views to corporate managements. The SEC’s recent decision to require mutual funds to disclose how we vote our proxies is a long overdue first step in increasing our motivation to participate in governance matters. But we also need the ability to act—“access” to corporate proxy statements—so that we can place both nominations for directors and proposals for compensation policy and business conduct directly in the proxies.

Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania, for his assistance in providing the data for Exhibits VIII and IX. His book “Stocks for the Long-Run” (Irwin, 1994) is a splendid reference. He also helped with innumerable supplemental materials.

the fund’s volatility during those inevitable times when stock prices tumble. But “slightly lower” must be what the client is given to expect. In any event, it is important that the client understand that it is next to impossible to “market-time” a changing cash position. And most important of all, the client must understand that, in a positive stock market over time, he will pay a commensurate price in relative rate of return. Put simply, he should understand that, over the long-run, a percentage point increase in volatility is meaningless; a percentage point increase in return is priceless. That powerful, and, I think virtually unarguable syllogism, should give both adviser and client ample food for thought. Confronting the Index Challenge In this age of investment relativism, I’m convinced that—faced with the competition of index investing and quantitative investing—too many managers today are responding in the most ineffective manner possible, by “closet indexing.” But shaping an inchoate and undisclosed policy around the structure of an index is, finally, managerial suicide. It is the ultimate concession to the unarguable economic value of the low-cost, passively managed index fund over the high-cost, actively managed traditional fund.

The Unexamined Life? But I’ll bet they do worry! In the quiet of the evening and the sometime loneliness of the soul, many of those who shouldn’t need to reflect on the value of hard work and a life well-lived doubtless do exactly that. But whether they do or not, surely we who have been blessed in the past with what passes for success, and you who are gaining the education and social graces that are often deemed requirements for future success—we who by the blessings of our birth, our genes, our talents, our luck, and the help others have given us—deserve no such exemption. Everyone here this afternoon ought to heed Socrates’ warning, “The unexamined life is not worth living.” So examine your life and remember that we’re all in the human race together—those of us who earn a reputation through our careers, those who undertake the nobler missions of life, and those humble souls who do the world’s hard work, to say nothing of you here today who, by virtue of your education, your ambition, and your higher promise, will be required to carry the torch for a new and better generation, and are preparing yourself for the task. Don’t miss the opportunity you have been given. For every single one of us, the job begins with getting up in the morning, going through the day trying to make the world a better place—even better by a tiny amount—and as a result, entitled to enjoy a well-earned night’s rest.

begun as I began to write this speech ten days ago." And that's exactly what happened as the stock market drop tumbled by precisely 50%. With the market's 41% recovery from the lows (leaving it 31% below its peak) many of the bubble's excesses have been corrected. So now let's set some reasonable expectations for what stocks might do in the next ten years. The dividend yield has nearly doubled, to 1.8%. With the same 6% earnings growth assumption—hardly guaranteed!— the future investment return on stocks could be in the 7% to 8% range. Will speculative return add or detract from that figure? With p/es now around 18 times (based on "normalized" operating earnings, which is a bit of a stretch), I'm dubious that we will get much help—or, for that matter, much harm—from that source. So reasonable expectations—seasoned as always with optimism—suggest a future annual average return on stocks in the range of six to nine percent. But don't agree with me uncritically. Make your own forecast: Just add your own earnings growth estimate to the 1.8% dividend yield, and take a guess at speculative return. Then combine them. But never forget that it's unwise to forecast stock returns without evaluating the broad reasons that will shape them. What About Bonds? Now consider what returns bonds might provide in the coming decade.

decline—which was to reach 50%—following the burst of the earlier Go-Go bubble in the market. They banded together to fire me, accomplishing the deed on January 24, 1974. I was devastated. But I promptly set out to recoup my job. In brief, I was able to persuade the directors of the mutual funds that were managed by Wellington to set off on a new course: Establishing a staff dedicated solely to the funds shareholders’ best interest; operating, not for a percentage fee but on an at-cost basis; and giving the funds complete independence from the managers who had fired me. I named the new company after Lord Nelson’s flagship HMS Vanguard—another lucky break—and described our unprecedented foray into running truly mutual mutual funds as The Vanguard Experiment, a test of whether our novel corporate structure and unprecedented form of fund governance that focused on profits to fund shareholders rather than profits to fund managers could succeed. In the words of author-economist Peter L. Bernstein: Jack Bogle’s goal was to build a business whose primary objective was to make money for his customers by minimizing the elements of the inherent conflict of interest (between seller and buyer), but at the same time be so successful that it would be able to grow and sustain itself. It has been no easy task. Strategy Follows Structure We were incorporated in September 1974, almost at the very bottom of the bear market. Our asset base was $1.

It was the opportunity of a lifetime: to at once prove that the basic principles enunciated in Samuelson’s “Challenge to Judgment” could be put into practice and work effectively, and to mark this upstart of a firm as a pioneer in a new wave of industry development. With the inspiration of Keynes and Samuelson, and even a touch of foresight, luck, and hard work, the idea that had begun to germinate in my mind in my ancient senior thesis could finally become a reality. The initial press reception to the announcement of Vanguard’s filing of the groundbreaking index fund IPO had been reasonably good, but bereft of a single hint that the index fund represented the beginning of a new era for the mutual fund industry. In fact, the reaction was best illustrated by a cartoon of Uncle Sam stamping out index funds, captioned “Index Funds are un-American.Professor

S&P 500 Index and Mutual Funds Rate of Return: 1981-1996 Before Taxes After Taxes Index Return +16.7% +15.1% Average Mutual Fund +14.3 +11.8% Index Advantage +2.4% +3.3% Funds Outpaced by Index 84% 92% Now, we'll calculate the same figures for the average mutual fund: l5-year pre-tax return of 14.3%, taxes of 2.5%, and after-tax return of 11.8%. The flow-through is just 83%. The table reflects the critical fact that the index itself ranks in the 84th percentile on a pre-tax basis, but rises eight points to the 92nd percentile after taxes. The former figure is largely shaped by the high operating expenses of the typical fund; the latter by the heavy tax burden engendered in this typically high turnover industry. In summary, during the past fifteen years-admittedly a good period for giant cap stocks-the absence of costs helped place the index just below the top, well, octile of mutual fund returns (84th percentile). The focus on tax minimization took it half way to the top (the 92nd percentile). Not too shabby, it seems to me for a passive index that didn't even have the putative advantage ofa skilled portfolio manager. Even these numbers overstate mutual fund rates of return to some degree, since poorer performing mutual funds drop out of the race, and thus out of the return calculations. And the impact that this "survivorship bias" has on reported industry returns is no trivial matter.

nothing is risk free. At what point are risks so low that they are negligible? What is the responsibility of corporations to disclose possible, but not proven, tiny risks? If they do, this can lead to “alarm fatigue,” where consumers learn to ignore warnings because they are everywhere. These questions become especially relevant to medical device makers or personal care products, which don’t go through as much (or any) of the rigorous testing that the FDA requires for drug manufacturers. How much testing should or can be done on a product before it is released and at what point has a company done all it can to identify and assess these risks before they are no longer held responsible is an open question. RepRisk also doesn’t look at any positive impacts, which are particularly relevant for a company like J&J which has the large positive impacts that are too often ignored. We believe that when assessing the impacts a company has it should be done on a net basis, as a company will get a lot of publicity when things go wrong but significantly less for the good things it does every day. In 2018, J&J provided 39,000 people with access to tuberculosis treatment and 52,000 people access to HIV treatment, trained 105,000 health workers in 67 countries and invested $11bn in R&D to develop new treatments that help patients live better and longer lives.

The sooner the SEC acts on this issue, the better. 2. Clearly Separate Ownership from Management. We need to recognize the distinction between directing—the responsibility of the governing body of an institution—and managing—the responsibility of the executives who run the business. It’s called the separation of powers. We need an independent board chairman, not the CEO; we need higher standards of director independence; and we may well require outside advisors or even a small staff to provide directors with independent information that is bereft of management bias on compensation, accounting, and other matters. 3. Return to a Long-Term Focus. Investor relations executive can help to unite owners and managers in returning the focus of corporate information to long-term financial goals, cash flows, intrinsic values, and strategic direction.“earnings

What toll would a 240 basis point cost have taken on the 12% return earned on the Standard & Poor’s 500 Stock Index over the past 50 years? A mutual fund incurring these costs would earn 2.4% less than the market, or 9.6%. When compounded, each dollar in the S&P 500 itself would grow to $287; each dollar in the fund, after costs, would grow to $96—a $191 dead-weight loss engendered solely by reason of the costs of financial intermediation. 1 Asset-weighted mutual fund ratio. The unweighted ratio is about 1.6%. Transaction costs and opportunity costs are estimated.

So, it would seem fair to reaffirm our earlier amendment of the BHB conclusion: “Although investment strategy can result in significant returns, these are dwarfed by the return contribution of investment policy, and the total return is severely impacted by costs.” An even more extreme conclusion was reached by William W. Jahnke, like BHB, a winner of the Graham and Dodd Award for an outstanding article published each year by the Financial Analysts Journal. Writing in a recent issue of Journal of Financial Planning, Jahnke concludes: “For many individual investors, cost is the most important determinant of portfolio performance, not asset allocation policy, market timing, or security selection.” Exhibit X: Equity Fund Expenses Lowest Cost Average Cost Highest Cost 1. Annual Percentage of Assets 0.2% 1.5% 2.2% 2. Annual Percentage of 10% Return 2.0 15.0 22.0 3. Ten-Year Percentage of Initial Investment 2.8 19.8 28.1 4. Percentage of Equity Premium of 3.5% 5.7% 42.9% 62.9% In any event, investors will profit by focusing on the concepts I have presented today (as shown in exhibit X) and considering the range of choices available:  Costs as an average annual percentage of assets managed (the conventional measure). You can pay 0.2% of assets to 2.2%. The choice is yours.  Costs as a percentage of total equity return. You can relinquish 2% of your return or 22%. The choice is yours.  Costs as a percentage of initial capital consumed over ten years. You can pay 2.

Even over periods as long as a quarter century, however, there have been variations in returns based on the esoteric force of speculation, rather than on the rock foundation of investment. But they have been reasonably subdued. The combination of dividend yields and earnings growth have remained the predominant driver of return. Exhibit IX presents the differences between the two. Actual returns fall within a range of plus or minus some two percentage points of fundamental returns in 88 of the 102 25-year periods since 1871. I was struck by the fact that there seem to be six waves—each of plus or minus 15 years duration—from the peak-to-valley role of speculation versus investment. Just for fun, I’ve delineated these six waves, arguably three grand RTM cycles, on the Exhibit. To illustrate just how these differences between fundamental and actual returns have worked in the past, I turn to Exhibit X, which compares the role of investment and speculation in two very different climates. When we moved from pessimism to optimism, as in 1937-1962, the fundamental return of 6.3% was supplemented by a speculative return of 3.1%. This additional return resulted from the upward reevaluation in the price of $1 of earnings, from $9.30 to $17.20, bringing total return to 9.4%. On the other hand, when optimism moved to pessimism, as in 1953-1978, the revaluation of $1 earnings from $9.90 to $7.90, resulted in a negative impact of -2.8%, reducing the fundamental return of 8.3% to 5.5%.

Yet too many mutual fund investors did exactly that, pouring a staggering $242 billion into growth and technology funds during the twelve months ended March 31, 2000, and actually withdrawing $42 billion from the lagging value funds. Yet as the 8. Do Not Overestimate Your Ability to Pick Superior Equity Mutual Funds, Nor Underestimate Your Ability to Pick Superior Bond and Money Market Funds Leading Bull Market Equity Funds in a Bear Market Rank Year-end 3/31/2000 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 3,784. 277. 3,892. 3,527. 3,867. 2,294. 3,802. 3,815. 3,868. 3,453. *3,896 Total Funds 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 3,881. 3,603. 3,785. 3,891. 1,206. 2,951. 2,770. 3,871. 3,522. 3,566.3/31/2001*

(IBM, which was to be the star performer of the subsequent two decades, didn’t join the Index until 1957.) Surprisingly, AT&T, with a market capitalization larger than General Motors’, was conspicuous by its absence. Despite its initial “Old Economy” base, the S&P Index dominated the active fund managers during the era that followed. Now advance the calendar to 1964. AT&T, now part of the index, had a 9.1% weight, followed by General Motors at 7.3%, Standard Oil of New Jersey at 5.0%, and IBM at 3.7%. The “top ten” then accounted for 39% of the index, again far higher than today’s top ten weight of 24%. But even this continued reliance on the Old Economy of autos, chemicals, oils, and utilities—together, 52% of the index—failed to diminish its sharp advantage over the average mutual fund during the subsequent decade, despite the surge of the “go-go” concept stocks during the middle of the period.

While it was fear—fear about more terrorism, fear about the economy, fear about the unknown—that clearly took over the marketplace during the first week after the stock market re- opened following the suspension of trading on September 11, we must recognize that we were also in the late phases of the burst in the technology stock bubble that reached its zenith in March 2000. Then, it was not fear that was in the saddle, but greed. Even without the terrorist attack, stock prices were resting on a precarious perch. While now we may well be probing for a sort of “fair value” for stocks, the market pendulum, having swung so far toward greed, rarely stops at fair value as it makes it way to fear. I’ve been in the profession of trusteeship and investing for a half-century now, and I believe the most helpful perspective is to think of stock prices as consisting of two discrete elements—economics and emotions.generated

Equity mutual funds incur operating expenses-largely payments to funds' managers-that average about 100 basis points (1 %), a levy likely to cut the returns their investors earn by 10% or more over time. Sadly, Mr. Buffett was misinformed. The average equity fund now carries total annual expenses not of 100 basis points, but of upwards of 200 basis points (2%), "a levy," if! may revise the master's words, "likely to cut the returns their investors earn by 20% or more over time." Such costs are, well, unacceptable. And bond fund all-in costs-unbelievably-average some 1.2%, a simply unjustified levy on any gross interest yield. In fact, such costs would cut today's yield of5.1% on the long U.S. Treasury bond to 3.9%, or nearly 25%. Why would anyone buy a high cost bond fund? Expense Ratios: A low expense ratio is the single most important reason why a fund does well.low

For I’ve ignored taxes, though most fund investors cannot; I’ve also ignored the likelihood that the annual return of the fund investor, based on past experience, will not come anywhere near 2.2 percent.) So, yes, investment costs are at the crux of the ability of our nation’s families to earn the wealth to which they aspire.

Passivity in the Face of Power The pervasive passivity of stock owners in pressing their own interests presents an ironic counterpoint to the astonishing concentration of voting power among a relative handful of institutional managers. The nation’s 100 largest financial institutions hold 56% of all shares of U.S. corporations. Overwhelmingly (77 of the 87 private firms), these giant institutions are managers of both mutual funds and pension funds, responsible for $5.4 trillion of the $5.5 trillion private (non-state) total invested in stocks. We can examine the behavior of these investment managers to get some sense of why this passivity exists. One major reason is the short-term investment horizons that have, over the past several decades, come to characterize the field of money management. While corporate governance issues would seem to call for vital concern by the long-term investor, it is not much of an issue for the short-term speculator. So as mutual fund turnover leaped from a remarkably stable 15% annual rate during the 1950s and early 1960s to 100% (or more) since the late 1990s, interest in governance faded accordingly. If a six-year holding period for the average common stock in a fund portfolio once marked mutual funds as an own-a-stock industry, surely the one-year holding period of today marks us as a rent-a-stock industry.

But even if that recommendation is not implemented for a decade or more, Adam Smith’s legendary “invisible hand”—each investor acting in his or her own enlightened self-interest—will gradually bring about the changes I seek. If we investors simply have the wisdom to understand how the financial system works, and to move our own money where our own common sense dictates, then the system of financial intermediation that has failed so many investors in the modern era will change. One way or another, then, whether by government fiat or by the invisible hand of our citizens, the soul of capitalism—the traditional owners’ capitalism that served us so well, for so long—will be reclaimed. What “The Invisible Hand” Means Adam Smith was, of course, right. We owe it to ourselves to look after our own economic interests. Even in a financial system whose vast strength is punctuated with serious— and in some cases disabling—weaknesses, there is no law that requires us to be victimized, and, however rare they may be today, attractive options for investors remain.counterproductive

” For you can be sure that no one would have the temerity to promote a new strategy that has lagged the traditional index fund in the past.) Even including this recent advantage, the long-term margins of superiority achieved by these theoretically-constructed back-tested portfolios are not large—between 1 and 2 percentage points per year over the cap-weighted S&P 500 Index. How much of that edge would have been confiscated by their expense ratios? (The lowest is 0.28 percent; the average is about 0.50 percent; the highest that I’ve seen is 1.89 percent.) How much would have been confiscated by their extra portfolio turnover costs compared to the classic index funds? How much would have been confiscated by extra taxes paid by shareholders when that turnover results in gains? Even if the modest margins claimed in the past were to repeat—which I believe is highly unlikely—these back-tested hypothetical returns, ignoring fund expenses, sales charges, and portfolio turnover costs, would be significantly eroded if not totally erased by those costs.

The managed fund then provides an ever more index-like portfolio, until it becomes a virtual index fund—but without the added value provided by low operating and advisory expenses, microscopic portfolio turnover and commensurately lower taxes, and a fully invested participation in equities. In short, today’s chance of victory, as small as it demonstrably is, will become tomorrow’s certainty of defeat if managers offer tacit index funds with high fees, high portfolio turnover, and a significant position in cash reserves. And it is the mutual fund shareholder who will pay the price. Relativism suggests that managers are becoming more similar to the enemy—“if you can’t beat ‘em, join ‘em.” But in the long-term, it is being different that gives an individual manager at least a fighting chance to win the battle for extra market return. Surely holding to a clearly differentiated strategy—and, for mercy’s sake, keeping a tight lid on fees and other costs—to cope with the realities of index competition is better than just standing there and hoping, again in Mr. Micawber’s words, that “something will turn up.” I acknowledge that not all fund managers subscribe to the new relativism. Indeed, some of the better managers in the field find it repugnant.magazine

While history gives us few clues to what lies ahead for bond returns, the present provides an excellent clue, so the parameters of future bond returns are reasonably easy to establish. Again, Keynes' analysis helps, for the investment return on bonds—remember, "forecasting the prospective yield of assets over their whole life"—depends largely on the interest payments they generate. Result: The current yield-to-maturity of bonds explains a remarkably high proportion of their return on the subsequent ten-years. In fact, the correlation between the initial yield and subsequent ten-year return of bonds is a healthy 0.91, close to a perfect 1.00. In 1980, for example, the yield on an intermediate-term U.S. Treasury bond was 12.4%; the return during the subsequent decade was 12.5%. In 1990, the yield was 7.7%; the return in the following ten years was 7.5%. Today, with a diversified portfolio combining Treasury and corporate bonds yielding about 5%, bond returns in the coming decade are likely to range between 4% and 6%. Chart – The Bond Market-Current Yields vs. Future Returns So in stocks and bonds alike, we're looking at a new era—but a new era of subdued returns. But if our central figures for future returns are anywhere near right— 7½% for stocks, 5% for bonds—the equity risk premium would approximate 2½%, somewhat below, but broadly consistent with, historical norms.

The counterproductive leap in fund portfolio turnover—which rose six-fold (from 14% annually to an incredible 117%) from 1960 to 2001—must be reversed, as we return at long last to our original focus on middle-of-the-road funds, and on long-term investing that emphasizes, not the price of the stock, but the value of the corporation. And all of this foolishness about earnings “guidance,” these forecasts of unsustainable growth rates for American corporations, and the managed earnings that haunt our capitalistic system must be replaced with realistic expectations and principled accounting standards. And fees will have to come down.diversification)

But if we had to spend, say, an extra $100 million on technology this year, it would raise our expense ratio by only two basis points, a change that the world would little note nor long remember. (But we would notice. So I assure you that our severe cost discipline remains intact.) The point is that our huge expense ratio advantage enables us to spend what is required to provide state-of-the-art financial services—services that meet and, ideally, exceed the ever-growing expectations of our clients. It also enables us to pay our crewmembers fairly, for our success depends on a terrific effort from each of the 10,000-plus human beings who serve on our crew. We offer competitive salaries, to which we add an extraordinary benefit program. On top of that, we provide the Vanguard Partnership Plan, affording each crewmember, from his or her first day on the job, ownership in units in a partnership. Earnings are based on a formula driven by the dimension of our cost advantage and the performance of our funds relative to their peers. By so doing, we share a small portion of our clients’ extra earnings with those who labor ceaselessly in their behalf. The Partnership Plan reemphasizes to our crew the low-cost mission that is central to all we do, focuses crewmembers on operational efficiency and cooperation, and drives home the message that providing more-than-competitive returns to our shareholders is essential to our growth, indeed to our survival.

them. Price/earnings ratios were replaced by price/sales ratios; volume of goods sold was replaced by visits, impressions, and eyeballs. Rather than analyzing, analysts came to predict the future, without removing the rose-colored glasses that became the analysts’ hallmark. Many analysts came to be paid multi-million dollar salaries, not because they could predict high earnings growth with accuracy (recent events have surely given the lie to that supposition), but because puffing a corporation’s prospects might give their investment banking colleagues a chance to underwrite the client’s next foray into the capital markets, while a negative report might cost them the client. That may explain, according to a recent press report, why, among 8,000 stock recommendations by Wall Street analysts, only 29 recommended “sell.” And fifth, the mutual fund industry. It too poured fuel on the technology fire. Never mind that we were in a NASDAQ bubble, there was money to be made by fund sponsors in selling technology funds to the public. Marketing strategy, of course, aims to sell the public exactly what it wants, and the mutual fund industry was quick to pander to the public’s taste. When tech stocks were ho-hum performers during the first half of the 1990s, only two new tech funds were formed. But when tech stocks approached their peak, the industry hares spawned them like baby rabbits—29 in 1999 and 71 more in the first quarter of 2000.

Turning to the third step of our strategy, the weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) of the portfolio at the outset of the year was 3.9% and ended it at 3.3%, so they became more highly rated. Whilst this is a good thing from the viewpoint of the performance of their shares and the Fund, it makes us nervous as changes in valuation are finite and reversible, although it is hard to see the most likely source of such a reversal — a rise in interest rates — in the near future. The year-end median FCF yield on the S&P 500 was 4.2%. The year- end median FCF yield on the FTSE 100 was 5.5%. Our portfolio consists of companies that are valued more highly than the average FTSE 100 company and a bit higher than the average S&P 500 company but with significantly higher quality. It is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap. Turning to the fourth leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a negative portfolio turnover during the period.we

He regularly examined his failings in a notebook he designed for the purpose, and was “surprised to find myself so much fuller of Faults than I had imagined, but I had the Satisfaction of seeing them diminish.” He began each day with “The Morning Question: What good shall I do this day,” and ended with the “Evening Question: What Good have I done to- day?” Even viewed through the lens of twenty-first century cynicism rather than eighteenth- century idealism, I confess a sense of wonder at the young Franklin’s moral strength and disciplined self-improvement. While few of us in today’s society would have the will to pursue a written agenda of virtue, Franklin had established, in his own words, the “character of Integrity” that would give him so much influence with his fellow citizens in the struggle for American independence. Wrapped in integrity and virtue, his character was also central to his dedication to the public interest. It is in that sense that his true entrepreneurship emerges. Franklin took joy from his creations and from exercising his ingenuity, his energy, and his persistence.of

4 billion, spread among eight mutual funds, all but one of whose portfolio managers had performed poorly in the market decline. Money management and distribution were still the responsibility of my former partners at Wellington Management, and our new charter limited us to administration, and nothing more. Our mutual structure would be key in our mission to become the lowest-cost provider of financial services in the world; our strategy would be to create simple mutual funds in which low-cost was not only essential to investment success, but would represent, dollar for dollar, the difference between success and failure. Strategy follows structure. We had been in operation for but three months when the first seeds of that simple vision were sown.500

Academic studies estimate that over fifteen years, the aggregate returns of mutual funds are overstated by as much as 1%, bringing the 11.8% after-tax return reported above to 10.8%, and raising the Index advantage to +4.3o/o-nearly a 50% increase (before compounding!) Adjusting the average mutual fund returns to correct for this bias, then, leads to even more dramatic fund underperformance than traditional comparisons show. That said, I must in fairness state that the returns of index funds are also lower than the returns of the Index, because they are reduced by portfolio turnover and operating costs. No matter how modest they may be, these costs exist in the real world. During the past 15 years, for example, the Vanguard Index Trust 500 Portfolio had returns of 16.4% before taxes and 14.3% after taxes (compared to 15.1 % for the Index itself), placing it in the 8151 and 86th percentiles, respectively among the surviving mutual funds.

It wasn’t too many years ago when there were no consolidated fund statements (each fund was treated like an individual stock), and when information came by mail, usually a month or more after the quarter ended. Thanks to technology, we’ve come a long way in a short time, and fund investors now receive better information, better organized, and available in what amounts to real time. But, like the wealth of publicly-available fund information, this wealth of proprietary account information has only a tenuous relationship to improving the returns of investors. To whatever avail, it’s easy to see how important, timely, and comprehensive information is to investors who are moving money from one fund to another, to investors who are paranoid about performance, and to investors with short-term horizons. But to what avail is this plethora of comprehensive, up-to-the-minute information to true long-term investors—the kind of investors whom Vanguard has sought—who are putting their money to work in middle-of-the- road funds (even index funds!)that

fund advantage—expense ratios that are 70% lower on average and portfolio turnover that is reduced by some 50%—strongly suggest that bond indexing will continue to deliver superior returns in the future. While the wisdom of bond indexing, like the wisdom of stock indexing, seems beyond challenge, there is precious little bond indexing going on in the fund industry. Not a single fund sponsor has yet to challenge Vanguard’s monopoly in the three defined-maturity categories, and the total assets of all of the bond market index funds managed by our rivals has yet to reach $6 billion. By contrast, assets of the Vanguard bond index funds now themselves approach $26 billion and assets of our Total Bond Market Fund, at nearly $21 billion, mark it as the second largest bond mutual fund in the world. Clearly, we need more education, awareness, and development of bond indexing for those with the wisdom to invest for long-term returns in the bond market. The Wisdom of Balanced Indexing If both stock index funds and bond index funds are so demonstrably and explicably effective, why not a balanced index fund? That’s exactly what we created in 1992. The fund allocates 60% of its assets to the Wilshire 5000 Total Stock Market Index and 40% to the Lehman Brothers Aggregate Bond Index, rebalancing essentially on a daily basis. It has worked inordinately well. The Wisdom of Bond Series Indexing Avg. Annual Returns, Apr. 1994 - Oct. 2001 1% 3% 5% 7% 9% 11% Short-Term Int.

Reasonable as these ranges seem to me—though they are in no way assured—I just can’t imagine deciding to go with that particular growth fund simply by reason of its putative superior future return under these tenuous assumptions. In all, I believe much of our industry’s information technology is presenting investors with hypothetical information clothed in the mantle of precision. Long-term investors, I think, would be far better served to simply stop trying to outguess the unguessable, and opt for using a simple asset allocation plan, not a complex one: owning the entire stock market, not trying to select winning stock funds based on their past returns. Sometimes it is better to be roughly right than precisely wrong.and

The long boom in the real estate market has now turned down, with home prices in retreat, so similar to what happened in the “new era” stock market early in 2000, and stock prices remain below the levels they reached eight long years ago. As I see it, our policy makers are running scared, with the Federal Reserve making credit available to banks (likely a necessary step) and driving short-term interest rates down (great for borrowers but terrible for lenders and savers, and probably terrible for the dollar). I’m not at all sure that this is sound policy-making, for it increases the likelihood that inflation will rear its ugly head later on. Our political leaders, too, seem to have pressed some sort of panic button, enough to unite a Democratic congress and a Republican administration in an election year. But I’m also concerned that the $160 billion fiscal stimulus plan—right out of Keynesianism—will not provide much in the way of stimulating the economy, even as it adds to an already staggering deficit in the Federal budget. Yes, it’s easy for our politicians to give money to “the people,” for of course it’s these self-same people who are in fact doing the giving. When they pay for the “gift,” either through higher taxes or through devalued dollars, that truism will become clear.

decades—increasing at an annual rate of 25%—it is clearer that declining costs are just one more myth. Myth #5. Mutual Funds are Meeting the Reasonable Expectations of Investors. Given the high fees and operating costs, the short-term investment horizons, and the substantial transaction and tax costs that go hand-in-hand with this rise in investment activity, it is small wonder that mutual fund returns have lagged so far behind the substantial returns generated by U.S. stocks during this greatest of all bull markets. Assuming only that the expectation of most fund investors is at least to enjoy a fair participation in the long-term returns generated by common stocks—and that seems a minimal assumption indeed—the idea that mutual funds have met the reasonable expectations of investors proves to be yet another myth. I am speaking not only of the failure of the average fund to match the returns of the Standard & Poor’s 500 Stock Index. While that large-cap index is not a bad comparison—after all, it represents 75% of the stock market, and its return has been identical to that of the total stock market over the past 30 years—it is a crude comparison, given that nearly one-half of all equity funds today focus principally on mid-cap and small-cap stocks.

Samuelson himself. Writing in his Newsweek column in August 1976, he expressed delight that there had finally been a response to his earlier challenge. Now such an index fund lay in prospect. “Sooner than I dared expect,” he wrote, “my explicit prayer has been answered. There is coming to market, I see from a crisp new prospectus, something called the First Index Investment Trust” (the original name of what is now Vanguard 500 Index Fund). He noted that the fund met five of his goals: (1) availability for investors of modest means; (2) proposing to match the broad-based S&P 500 Index; (3) carrying an extremely small annual expense charge, (4) offering extremely low portfolio turnover; and (5) “best of all, giving the broadest diversification needed to maximize mean return with minimum portfolio variance and volatility.” While our IPO almost failed (the goal was $150 million; the capital finally raised came to but $11 million), we began operating our tiny index fund in August 1976. Mutual Admiration Paul Samuelson and I met face-to-face only perhaps a half-dozen times during our (arguably) 61-year relationship. But he often sent me notes, and must have made at least a score of telephone calls to me in my office. But as time went on, I appreciated not only his brilliance,

Nonetheless, I hold the absolute conviction that my crusade places me on the right side of history, and that positive change will one day result from my efforts. And I’m not giving up. After all, how could I possibly ignore final inspirational saying in that litany of family values that I told you about at the outset: “Press On, Regardless.”

Then, rather than chasing after that rabbit, finding that it’s fake, and quitting in dismay, like the greyhound we met, let’s just make sure that we chase the real rabbit of life, and then keep running, and running, and running, as hard as we possibly can. Just what is that real rabbit? How could anyone possibly know? But I think it has something to do with using whatever talents God is generous enough to bestow on us, as best we flawed human beings can, to serve our fellow man. We could do worse than honor William Penn’s timeless words: I expect to pass through this world but once. Any good therefore, that I can do, or any kindness I can show to any fellow creature, let me do it now. Let me not defer or neglect it, for I shall not pass this way again. Modern-day capitalism, alas, has strayed far from that noble creed.the

The reversion to the mean among the top quartile funds during the 1970s, for example, was -4.8% during the 1980s, virtually identical to the 1980s-1990s reversion of 4.2% Reversion to the mean, then, seems almost preordained in fund performance, frustrating the dreams of so many investors who invest on the basis of past performance. Finally, index funds alone have relative predictability. They provide precisely the market’s return, less their costs, decade after decade after decade. Rule 7: Rely on Past Performance to Measure Consistency and Risk While the dream of the perfect investment plan will rarely be fully realized, there are ways to avoid having it become a living nightmare. If past fund performance cannot foretell the future, it can still be an important consideration in selecting funds that have a fighting chance to earn consistent returns relative to peer funds with similar styles and objectives. Compare, for example, a large cap blend (growth and value) funds with other large cap blend funds, and see how it stands each year.

earlier chart on style diversification showed, that was exactly the period when investors should have been moving out of growth and technology funds and into value funds. What folly! When it jumps on the bandwagon of past performance, the crowd is always wrong. Pillar 9. You May Have a Stable Principal Value or a Stable Income Stream, But You May Not Have Both. Contrast a money market fund—with its volatile income stream and fixed value— and a long-term government bond fund—with its relatively fixed income stream and extraordinarily volatile market value. Intelligent investing involves choices, compromises, and trade-offs, and your own financial position should determine the most suitable combination for your portfolio.2 As 1991 began, the yield of the average money market mutual fund was just under 6%, and the yield on a long-term U.S. Treasury bond fund was just over 7½%. During the ensuing decade, the value of a $1,000 investment in the money market fund never varied, while $100 invested the bond fund fell to as low as $93 (in 1992) and rose to as high as $123 in 1998. Stable principal vs. variable principal. But the annual income on the $100 money market fund investment was not to approach $6 again until 2000. Indeed, with declining interest rates, annual income is now on the way to the $4 level. The annual income stream on the $100 initial investment in the long-term bond fund, on 2 In my book, I compared a 90-day U.S. Treasury bill with a 30-year Treasury bond. $1.

guidance,” pernicious yet still omnipresent, should be eliminated. So should efforts to meet financial targets through creative accounting techniques. 4. Let Sunlight Shine on Accounting. Given the enormous latitude accorded by “Generally Accepted Accounting Principles,” owners must demand, and managers must provide, full disclosure of the impact of significant accounting policy decisions. Indeed, maybe we ought to require that corporations report earnings not only on a “most aggressive” basis, (presumably what they are reporting today), but on a “most conservative” basis as well. Bring Back Dividends! But there is something even more important than these four items on my agenda: Bring back dividends! Benjamin Graham also reminded us of something that we’ve long forgotten: “There is no truth more fundamental in investment than that dividends and market value are the only concrete returns a public stockholder ever gets on his investment. Earnings, financial strength, and increased asset values are of vital importance only because they will ultimately effect his dividend and market price.” Again, he was—and is—right. And it is high time that owners and managers unite to bring a new focus on the issue of dividends. History tells us that higher dividend payouts are actually associated with higher future returns on stocks. Yet despite the absence of evidence that earnings retention leads to sound capital allocations, the payout rate has been declining for years.

suggests that it is caused by “aggressive marketing executives who see short-term numbers as the best way to attract new shareholders.” One top strategist says, “that’s the marketing side of the business talking, not someone with a fiduciary duty.” Another asserts, “relative investing is ridiculous.” Still another routinely consults what he describes as his 11th Commandment: “Thou shalt not do relative investing.” Warns another, “relativity worked well for Einstein but has no place in investing.” Such mutual fund managers who elect to be different—and I wish that there were more of them—need to make it absolutely clear to shareholders that their returns will not closely track the quarterly returns, nor even the annual returns, of a market index, even as the managers should make it equally clear that their expectation is to outpace the market over the long run. The short- term nature of today’s pervasive environment of comparisons is merely noise, a discordant element that ill-serves managers and financial markets alike. In this context, I reiterate a thought, courtesy of William Shakespeare, contained in my book. I describe the short-term noise in the market as “a tale told by an idiot, full of sound and fury, and signifying nothing.” In short, relativism is the triumph of process over judgment. I believe that it is possible for some managers to apply judgment borne of wisdom and experience to outpace the market over time, without assuming undue risk.

Who Earns the Market Returns? But whatever returns the financial markets are generous enough to deliver, please don't make the mistake of thinking investors actually earn those returns. To explain why this is the case we need only to understand the simple mathematics of investing: All investors as a group must necessarily earn precisely the market return, but only before the costs of investing are deducted. After all the costs of financial intermediation are deducted—all of the management fees, the transaction costs, the distribution costs, the marketing costs, the operating costs, and the hidden costs of financial intermediation— the returns of investors must—and will, and do—fall short of the market return by an amount precisely equal to the aggregate amount of those costs. Result: Beating the market before costs is a zero-sum game; beating the market after costs is a loser's game. The returns earned by investors in the aggregate inevitably fall well short of the returns that are realized in our financial markets. The great paradox of investing is that you don't get what you pay for. The fact is quite the opposite: You get what you don't pay for. Consider the costs of equity mutual funds. Management fees and operating expenses—the "expense ratio"—average about 1.6% per year of fund assets.

The net result is that that the performance of the average fund was somewhat better than it appeared during the surge in large-cap stocks from 1994 through 1998, even as it was worse than it appeared during the small- cap outperformance of 1990-1993 and in the past 16 months. But more sophisticated comparisons are readily available. For example, we can compare large-cap funds with a large-cap index (the S&P 500 is fair enough), and compare mid- and small-cap funds with indexes of mid- and small-cap stocks. Result: on a pre-tax basis, over the past 15 years, large cap funds have lagged their benchmark by 2.9 percentage points per year, mid-cap funds by 4.7 points, and small-cap funds by 2.0 points. (Given the high failure rate of funds, I’ve tried to adjusted conservatively for survivor bias, using an average of 1.2%, but— generously!—ignored sales charges.*) On an after-tax basis, as you might expect, the lags increase substantially, to 4.5, 6.2, and 3.0 points _____________ *I believe my adjustment for survivor bias is extremely conservative. Princeton’s Burton Malkiel calculated survivor bias during 1976-1991 at 4.2% per year.

world anew.” So, you young citizens, please never, never lose your idealism. And, to those of you who are older, (even if you’re my age), don’t you dare lose yours either. And if perchance you have lost it, get inspired by our new generation and find it once again. Now.

3) The strongest (meaning lowest cost, highest quality) bond and money market line-up 4) The greatest reluctance to pander to the public taste in their new fund offerings 5) The lowest portfolio turnover 6) The greatest tax-efficiency 7) The longest holding periods by their own shareholders. And most firms that have one of those high SQ characteristics, have all of them. (Just check the record.) But there aren’t nearly enough high SQ firms, and even those that do possess high SQs have room for improvement. That improvement will come, day by day, week by week, year by year, as investors turn to high SQ firms. And as they do, other firms will be compelled to raise their own SQs, placing the mutual fund industry’s dominance on a far firmer foundation. Back to Basic Principles To make this transition requires only that investors speak and managers listen. In order to solidify mutual fund dominance, we need to develop the will to go back to basics like these:  We must honor fundamental investment principles such as asset allocation and diversification.  We must recognize that intelligent long-term investing means a focus on the value of the corporation rather than the price of its stock.  We must remind ourselves that the returns that investors as a group receive are, by definition, the returns earned by the financial markets, minus the costs of the intermediaries.

I should also note that the universally accepted use of the S&P 500 Index as the de facto indexing standard is subject to the criticism that it consists mostly of large-cap stocks, and represents "only" 70% of the entire market. The Wilshire 5000 Equity Index is, I think, a better basis for indexing, not only because it encompasses mid-cap and small-cap stocks as well as large cap stocks, but because a portfolio linked to the entire stock market can be expected to have the lowest possible portfolio turnover. Yet while there is a high degree of certainty that the low cost advantage of indexing will persist, there is a somewhat lower level of certainty that the deferral of gain realization will persist. First, index funds, by virtue of their low turnover, build up their unrealized gains over time. Somewhere way down the road, those gains will inevitably be realized. Second, despite the intention of an index fund to avoid realization, it is susceptible to a run of shareholder redemptions that could force it to liquidate highly appreciated portfolio holdings. Nonetheless, given the value of tax deferral even for a limited period, it is difficult to visualize a circumstance under which the potential tax advantage offered by index funds, relative to traditional actively managedfunds, will not persist.

Given our fund’s relative youth, let’s look at balanced indexing over a longer-term time horizon. Using the fund’s actual results during the past eight years and recreating the results of a composite 60/40 balanced index for the earlier years (and deducting appropriate costs), we can examine a full 15-year period. The results are impressive: The average annual return for the balanced index fund from the end of 1986 through October 2001 came to 10.9%, vs. 9.2% for the average balanced fund, a 1.7 percentage point advantage, once again explained largely by relative costs. An initial investment of $1 million grew to $4.64 million in the balanced index fund vs. $3.69 million in the average managed balanced fund—an advantage of nearly $1 million, again obtained simply by shifting the allocation of market returns away from the managers and toward the investors. The consistency of the balanced index fund’s superiority was remarkable. It provided virtually the same returns in five years, and lower returns than the balanced fund average in only a single year (2000), earning a higher return in nine of the 15 years. What is more, it achieved its superiority with a risk exposure 10% below that of the average balanced fund (standard deviation of 9.2% vs. 10.3%). While most balanced mutual funds have traditionally hewed to a fairly steady equity ratio of around 60% in stocks, the same can not be said about pension funds. To their obvious detriment, U.S.

During that final, overheated surge of tech stocks, tech funds accounted for fully 30% of the all-time record high of $112 billion of cash that flowed into equity mutual funds during the quarter. Alas, the 92% annualized return that the established tech funds had achieved during 1999 and early 2000 promptly—and predictably—vanished, with tech funds now off nearly 70% from their March highs. Millions of dollars of fees to the managers, billions of dollars of losses to the investors. Sweet marketing, it turns out, is usually sour investing. 0 0 1 4 3 7 10 8 8 3 0 1 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mar-00 Dec-00 Mar-01 Tech funds started Value of $1 Technology Funds - Supply and Demand Formation Follows Performance $24.16 $9.02 $8.Funds

by American business, the annual investment return achieved simply by adding the initial dividend yield to any increase in earnings per share. Today, the dividend yield is a bit over 1%, and corporate earnings in the U.S. have grown over the long-term at a 6% to 7% annual rate— about the same rate as our economy, measured in nominal terms by our gross domestic product. Adding the two together, the obvious result: An investment return of 7% to 8%. But it is not only these economics that drive the market. We have to concern ourselves with emotions, measured by the change in the amount investors will pay for each dollar of earnings—the p/e ratio. If it goes from 20 to 24 times in a year, add a mere 20%(!) to the market return. From the start of the great bull market in 1982 to its high last March, the market’s p/e rose from 8 to 32, a cool 300% gain, equal to 7% per year. The great bull market, then, was a not product of the (in fact) normal earnings growth during the period, but a product of our emotional exuberance. It is inconceivable to me that that scenario will repeat itself. Indeed, today the p/e ratio is about 30 times based on this year’s estimated sharply lower earnings, and a still high 22 times relative to what are probably normalized earnings. In any event, we are likely to be facing an extended period with an economic return of no more than 7% or 8%.

Just one more example. In 1980, with the quantum surge in oil prices and high expectations for the petroleum industry, the energy sector’s weight rose to an all-time high of 32%. It would have seemed, I suppose, foolish to own such a single-industry-dependent index fund back then, and in fact during 1976-1985, the index didn’t, well, fly very impressively. Nonetheless, the long-term record of the S&P 500 over the past half-century, as we have seen, brooks no apologies. Like the bumble bee, the index can fly. And on long trips, it can soar. Today, of course, the index has an equally heavy weighting in the “New Economy,” including an important dependence on technology stocks (32% as year 2000 began, now 27%). I admit that concentration unnerves me a bit. But I’m such a believer in the magic of indexing that I remain unshaken in my conviction that, no matter what the short-term holds, indexing continues to represent the best way to invest for the long-term. Finally, broad diversification, low cost, minimal portfolio turnover, and tax-efficiency conquer all. Is the S&P Really “The Market”? For all of its well-known idiosyncrasies, the S&P 500 has proven it can be an excellent representation of the stock market itself. Composed solely of large-cap stocks, it represents about three-quarters of the market’s total capitalization; its returns have maintained a fairly stationary correlation (R2) of 0.

Human Beings For to build a successful firm, it takes more—yes, it does!—than killer apps like index funds, structured fixed-income funds, and low-cost actively-managed equity funds. And the second factor—in addition to our low cost structure that is essential to our investment strategies—that makes Vanguard attractive to long-term investors is the investment services we provide. Not just the services themselves, but the fact that they are focused on human beings. Please never forget that it takes a focus on human beings—as I’ve said 1000 times over, “honest-to-God, down-to-earth human beings with their own hopes and fears and objectives.”—to implement a winning corporate strategy. The first step is to recognize that each one of our clients is an individual human being. We may know much about our client’s investment goals, but we must never forget that investment success is as much based on human emotions as on economics. So, it is our responsibility to explain with complete candor what investing is about: investment returns, which we must acknowledge we cannot control; and asset allocation, risk, cost, and time, the control of each of which lies at our fingertips. A focus on human beings, furthermore, requires that we act with integrity, earning the confidence of our clients that we will place their interests ahead of our own.

success, exercising his talents with a view not toward personal gain and private profit, but toward serving the community. “America’s first entrepreneur” may well be our finest one. The idea of a contributor—“one who bears a part in some common design,” according to a 1793 dictionary—seems archaic to our ear. But 250 years later, Franklin’s idea of contributionship—a shared mutuality of interest for a common purpose—is the defining characteristic of Vanguard. As Franklin’s stove and lightning rod and all of his other contributions to science and to mankind fostered the public good, so we have freely shared with others the fruition of our mutuality, the index fund. And both our structure and our invention arise almost entirely from our firm’s value system and the corporate character that we firmly established more than a quarter-century ago, which have undergirded all that we may be judged to have achieved thereafter. I hope you will forgive my boldness in comparing the peerless accomplishments of our nation’s first entrepreneur with my own humble enterpreneurship and inventiveness, my own joy in what providence has led me to create, my own energy and persistence, and my own attempts to improve the lot of the American investing public. Of course I’m proud, but I console myself with these words of Benjamin Franklin, written when he was 78 years of age: In reality, there is, perhaps, no one of our natural passions so hard to subdue as pride.

they expect to call on, say, 30 years hence? Wouldn’t they be as well served—or better served— by buying right, holding tight, and checking on their account once a year or so? That kind of discipline will pay off in the long run. Knowledge may be power, but the fact that fund investors are receiving better information than ever before has been largely offset by their using that information for the wrong purposes. The bandwidth of the human mind, I fear, has been overwhelmed by the staggering bandwidth of information now presented to us—even thrust on us. What should make fund investing better may well be making it worse. The trick is to convey the vast array of information available to fund investors in a sensible but focused way, so as to provide perspective—not merely on a one-way information highway, but through a two-way communication network. (4) Better Communications with Owners? To better communicate with our Vanguard shareholders, in recent years we have begun to use technology to enhance the services we provide. Today, fully one-third of our individual assets are held by shareholders registered on our website. And nearly 50% of our client service interactions take place over the web. Our goal is to give our clients the closest thing to personal service that is possible without actual face-to-face, person-to-person interaction, which, truth told is, as a practical matter, impossible.

8% of initial capital or 28.1%. The choice is yours.  Costs as a percentage of percentage of equity risk premium, an important new concept. You can relinquish 5.7% of the historical premium norm or 63%. Again, the choice is yours.

When managers of traditional active equity funds claim to have a way of uncovering extra value in our highly- (but not perfectly-) efficient U.S. stock market, investors will look at their past record, consider the manager’s strategies, and then invest or not. These new index managers are in fact active managers. But they not only claim prescience, but a prescience that gives them confidence that most sectors of the market (such as dividend-paying stocks) will remain undervalued for as far ahead as the eye can see. But, if these factors are underpriced, why won’t investors, hungry to capitalize on that apparent past inefficiency, bid up prices until the undervaluation no longer remains? Put another way, if these promoters of the purported new paradigms actually have been right in the past, won’t they therefore be wrong in the future? Interestingly, the choice of the ETF structure—rather than the standard mutual fund format—by these confident entrepreneurs would seem to belie the fact that their “fundamental indexing” approach may take decades to prove itself, if indeed it does so at all. Because by choosing the ETF format, they imply even more strongly that investors who actively buy and sell their new fundamental funds will lead to even larger short-term profits than buying and holding them for the long term. I recommend skepticism about these purported “new paradigms.” I’ve witnessed too many new paradigms over the years. None has persisted.

Index. Result: Average annual fund return, 9.8%; S&P 500 return, +11.3%. To magnify that 1½ percentage point difference, I assumed a large initial investment, and compounded it. Thirty years later, the original $1,000,000 investment had grown to $16,500,000 in the average fund, but to $25,000,000 in the S&P 500 Index. Difference: $8.5 million. Our mutual low-cost structure gave us the ability to match the index at nominal cost, and quickly led to our formation of the world’s first index mutual fund. Our structure was also the linchpin of the strategy to abandon our funds’ half-century commitment to a seller-driven broker distribution channel and move to a buyer-driven no-sales- load channel in February 1977. We made that unprecedented decision just five months after the index fund initial public offering was completed. (It had raised a less-than-mind-boggling $11 million.) Ditto for our second major innovation in fund management just four months later, this time in the bond market. Casting tradition to the winds, we formed, not a single so-called managed bond fund, but a troika: Long-term, intermediate-term, and short-term. This simple innovation, while less recognized than our creation of the first index fund, changed the way investors regarded bond funds. It quickly became the industry modus operandi. So, in less than two years from our start as a tiny administrative company, Vanguard had been transformed into the full-line fund complex it is today.

Given the hyper-short-term trading activity that now characterizes institutional investing, the forbearance of portfolio managers from governance issues actually reflects a perverse common sense. Why spend money on evaluating a company’s governance when you likely won’t even be holding your shares when the next proxy season rolls around? But there’s more than short-termism that accounts for the absence of funds from the governance scene. Consider that index funds—and other funds that follow essentially static buy- and-hold strategies—comprise some 25% of the assets of the Institutional 100. Yet the voices of these consummate long-term investors have been, if not totally silent, at least seriously muted. And even active managers engaging in what passes for low turnover in the current environment (say, below 35%) have generally refrained from intrusion into the affairs of the corporations in which they invest. One obvious reason for this passivity is the desire to avoid controversy. In the asset-gathering business that money management has become, a high profile on a divisive issue is more liability than asset.

But intermediation costs are paid in current dollars, while the investor’s final capital must be measured in constant dollars. During the past half-century, the inflation rate was 4.2%. Result: Real annual return for the S&P 500, 7.8%; real return for the fund investor, 5.4%. The final purchasing power of each initial dollar falls to $43 in the Index, and to less than $14 in the fund. Since the mutual fund’s annual return before costs was not the 12.0% stated return earned by the S&P Index, but a real return of 7.8%, the 2.4% intermediation cost reduced each year’s real return, not by 20%, but by almost 33%! When we apply to the annual data that remarkable magnifying glass called compounding, we can describe the investment returns earned by the average fund—on cost assumptions that are hardly excessive—as shocking. After intermediation costs and inflation (and ignoring taxes!), the nominal value of $287 had dwindled away to less than $14, just 5%—five percent!—of the compound market return we calculate from the textbook data—say, the Ibbotson tome—that shows the annual returns of the stock market. Yes, Embedded Alpha is a powerful destructive force. Other Destructive Forces But it turns out that there are other forces that are every bit as destructive as costs in undermining the returns earned by mutual fund investors.

My point in discussing the overpowering force of fundamental factors in driving stock returns is to emphasize that the economics of capitalism and competition seem somehow to have established an historic limit of 4% real (6% nominal) on long-term earnings growth. What is happening in the U.S. stock market today—and what has driven the stock market during its past three glorious years—is the notion that earnings growth has moved to a new, distinctly higher, plateau. Indeed, during the past 15 years, real returns have averaged fully 12.6%—a return significantly exceeded only five of the 181 15- year periods since 1816—and not by very much. (The record of 14.2% was set way back in 1865-1880.) Even if the coming decade produces but a 3% real return, the quarter century return would be 8.6%, far above the long-term norm of 6.7%. But the remarkable returns earned on stocks since 1982 have raised serious questions about whether the old shackles on fundamental returns have been ripped away, freeing America to enter a new era of corporate profitability. For equity investors, it is the central question of the day. A year ago, one respected firm headlined its investment strategy bulletin, “A New, Higher Mean to Revert To?”4 The report began by saying, “as the fat returns from U.S. equities keep piling up, you have to wonder if in this brave new world, the historical returns of 6%-7% real are obsolete, and have to be revised upward.” Then it took the middle ground.

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.

Morningstar Mutual Funds provides considerable help in this important endeavor showing whether a fund is in the first, second, third, or fourth quartile in each of the past 12 years. The chart gives a fair reflection of the fund’s relative success. For a fund to earn a top performance rating means, in my mind, at least six to nine years in the top two quartiles and no more than one or two in the bottom quartile. This information—shown in this example of two real-world funds that reflect the standards I’ve set forth—is ignored by too many investors. The “good” fund is in the top half in seven years, in the bottom quartile but once. The ‘bad” fund is in the top half five times, but in the bottom quartile, four. Interestingly, for the full period both funds had similar annual returns of 17 1/2%, and both ranked among the top one-third of their peers. But it is consistency of return, not aggregate return, that tells the important story to the intelligent investor. Morningstar Performance Profiles* Good Bad 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 A. Consistency * Quartile within Category. 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 So, careful analysis of past performance can tell us a lot about return. But it can also tell us a lot about risk. Risk is a crucial element in investing. One good indicator is the Morningstar risk rating.

Despite the importance of this issue, I know of not a single academic study that has attempted to calculate the value extracted by our financial system from the returns earned by investors, nor (as far as I know) has a single article on the subject ever appeared in the Financial Analyst’s Journal. Perhaps the best way to honor the legendary Benjamin Graham—and the value he created by his incisive view of our investment system—would be for us to tackle this vital, if largely unrecognized issue of investment costs. One week ago, Princeton’s 2007 valedictorian, Glen Weyl, described his passion for intellectual inquiry in this way: “There are questions so important that it is, or should be, hard to think about anything else.” There are questions so important that it is, or should be, hard to think about anything else. The functioning of our nation’s system of financial intermediation is just such a question. Please not only think about it, but think about how to make it function far more effectively than it does today.

In short, it is by no means obvious that this combined blast from our monetary masters and our fiscal authorities will make a positive difference either to our markets or our economy. Maybe, just maybe, we should not intervene and just let the markets clear. Not only are our markets driven by the confidence of investors putting their dollars on the line, but our economy is driven by the confidence of consumers spending on their needs and wants, and corporations, spending to enhance the returns on their capital. That confidence has been shaken. The inherent risk in our financial markets—enhanced in the recent present era by truncated time horizons, the dominance of speculation over investment, excessive financial innovation, easy credit, a seeming unawareness of burgeoning credit risk, and a concentration of assets in banking conglomerates—has markedly increased during the recent era. I share the concern of many economists that these problems in our financial system may well carry over to the performance of our economy, now approaching—if not already in—recession. If that is the case, we will see the leveling off of corporate earnings growth, perhaps followed by significant earnings declines. Thus, the probabilities favor continued market turbulence—and some economic turbulence as well. So the risks are high; the uncertainties rife. Yet perhaps we’ll muddle through. After all, throughout our 230-year history, America has always done exactly that.

operating expense ratios. In fact, the surest route to top quartile returns is bottom quartile expenses, a fact reaffirmed in all investment equity styles-small-or large-cap, growth or value-and all bond fund maturity ranges as well. Lower expense ratios are the handmaiden of higher returns. Once again, "little things mean a lot." Transaction Costs: In addition, with today's average fund portfolio turnover at an absurd 85% per year, transaction costs reduce returns by as much as 1/2 to 2.0 percentage points over and above fund expenses. What is more, it carries enormous tax costs. So favor low turnover funds. Taxes: If your fund holdings are in taxable accounts (i.e., other than in a tax-deferred IRA or a thrift plan), high turnover can not only cause you to pay full income taxes on short-term gains, but also deprive you of the extraordinary value of the deferral of capital gains taxes. (By the way, while high fund turnover hurts taxable investors, there is no evidence whatsoever that it helps tax-deferred investors). The odds against active managers outpacing the after-tax returns of index funds become enormous for taxable investors. So, never forget that taxes are costs too. Rule 2. Consider Carefully the Added Costs of Advice. It is the essence of simplicity for the self-reliant, intelligent, informed investor to purchase shares without an intermediary salesman or financial adviser. Their costs should consume the lowest possible proportion of your future returns.

folly of short-term speculation—are obliged to own (surprise!) stock and bond market index funds. As evidenced from the substantial shortfall in returns experienced by mutual fund investors in the example that I cited earlier, the investment merits of indexing—the broadest possible diversification, at the lowest reasonable cost, without sales loads or marketing fees, and with maximum tax efficiency—have proven themselves over and over again. Yes, I concede that owning such funds is as interesting as watching the grass grow, or perhaps as interesting as watching paint dry. But since less than 10 percent of investors or investment managers are apt to beat the market over the long-term, buying and holding a low-cost index fund and capturing nearly 100 percent of whatever annual returns the financial markets are generous enough to deliver to us seems a far better option than plunging headlong into a game rigged with such overpowering odds against success. Of course, since I started the first index mutual fund a little over three decades ago— Vanguard Index 500 is now the largest fund in the world—you would be wise to discount my passionate advocacy of indexing. So ignore me! But listen to Warren Buffett. Listen to Yale’s David Swensen. They both say exactly the same thing. Listen to Jack Meyer, the former—but equally sensational—manager of Harvard’s endowment fund. Listen to any Nobel Laureate in Economics, beginning with Paul Samuelson.

to the portfolio managers of the funds whose shares they trade. Yes, technology has driven transaction costs down. But it has also helped drive stock trading to its highest level since 1929, a turnover of 100%, meaning that the average stock is now held for just one year, compared to six years in the mid 1970s. The net result as described in a compelling law review article:1 . . . even as computer and network technology dramatically reduces the cost of and increases our access to information, our biological limits ensure that individual and institutional investors alike consider only a limited subset of all the data available . . . Purely speculative trading that springs from the natural dispersion of investors’ subjective opinions under conditions of uncertainty, however, drains investor wealth. And the new information technology may encourage speculation. In other words, securities markets may be subject to the law of unintended consequences just as the rest of life is . . . Unfortunately, if the demand for stock speculation is relatively elastic, reducing the marginal costs associated with speculative trading can have the perverse effect of increasing total costs (and with it, deadweight losses). At least a few others share my concerns about the role technology has played in creating this new world of hyperactive investing, and about the accelerating pace of investors’ turnover of fund shares. A recent New Yorker article described it in harsh terms: “. . .

spent a total of just 0.01% (half a basis point or one two hundredth of one percent) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary). Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2019 for the I Class Accumulation shares was 1.05%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the I Class Accumulation shares in 2019 this amounted to a TCI of 1.09%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing.

The "concept" stocks of the Go-Go years in the 1960s came, and went. So did the "Nifty Fifty" era that soon followed. The "January effect" of small-cap superiority came, and went. Option-income funds and "Government plus" funds came, and went. In the late 1990s, high-tech stocks and "new economy" funds came as well, and even today the asset values of the survivors remain far below their peaks. Intelligent investors should approach with extreme caution a claim that any new paradigm is here to stay. That's not the way financial markets work. We do know that traditional low-cost all-market-cap-weighted index funds guarantee that you will receive your fair share of stock market returns, and virtually assure that you will outperform, over the long term, 90 percent or more of the other investors in the marketplace. Maybe this new paradigm of “fundamental” indexing—unlike all the other new paradigms I’ve seen—will work. But maybe it won’t, too. I urge you investment professionals not to be tempted by the siren song of paradigms that promise the accumulation of wealth that will be far beyond the rewards of the classic index fund.general

the other hand, began at $7.91 in 1991, and has remained above $7.10 each year. It should be about $7.20 in 2001. Variable income vs. stable income. Is stable income or stable principal the higher priority for you? Or some of each? Be clear on what you plan to achieve in your defensive holdings, and invest accordingly. Pillar 10. Beware of “Fighting the Last War.” Too many investors—individuals and institutions alike—are constantly making investment decisions based on the lessons of the recent, or even the extended, past. They seek stocks after stocks have emerged victorious from the last war, bonds after bonds have won. They worry about the impact of inflation after inflation, having turned high real returns into so-so nominal returns, has become the accepted bogeyman. You should not ignore the past, but neither should you assume that a particular cyclical trend will last forever. None does. When I wrote my book, inflation was at the forefront of investors’ minds. But, ever the contrarian, I raised a caveat emptor suggesting that “it would be foolish to assume that inflation would be an eternal fact of life.” Sure enough, inflation, having averaged 5.7% during the fifteen previous years, has run at less than one-half that rate (2.6%) since then. “The last war,” it turned out, was over. Similarly, stocks in high-tech companies soared during the late 1990s, and large-cap tech stocks came to dominate the portfolios of growth funds.

Character Counts A lot has happened since the summer of 1977, but nothing has changed the stamp of character we placed on the firm during those formative years. It is the brute force of that character that drives us to this day: Simple funds designed to assure investors of their fair share of whatever returns the market is generous enough to provide, no more, no less; low cost and no sales commissions; a business strategy that departs from our structure at its peril; and serving our clients and our crewmembers with the respect and dignity that honest-to-God, down-to-earth human beings deserve. Here is where we now stand:  Vanguard’s assets total $565 billion. At the outset, we were the tenth largest fund firm; we now rank second, closing on the leader.  We had eight funds when we began; we now have 105, owned by 15 million investors largely in the U.S., but scattered all over the world.

Add another one-and-one-half percent in portfolio turnover costs, marketing expenses, and other smaller add-ons and the total cost of equity fund ownership roughly doubles, to about 3% per year. So yes, costs matter. How Much Do Costs Matter? How much do costs matter? A ton! Indeed, fund costs have played the determinative role in explaining why, for example, during the 1984–2002 period, the return on the average mutual fund averaged 9.3% when the return on the stock market itself averaged 12.2% per year. That 2.9% differential is almost exactly just what one might expect, given our 3% rough estimate of fund costs. (Never forget: Market return, minus cost, equals investor return.) Simply put, fund managers have arrogated to themselves an excessive share of the financial markets' returns, and left fund investors with too small a share. Chart – The Stock Market vs. The Average Equity Mutual Fund The conflict of interest between fund managers and fund owners explains the large performance gap between the average fund and the stock market itself. But there is another major conflict that has cost fund investors even more, for fund managers have moved away from being prudent guardians of their shareholders' resources and toward being imprudent promoters of their own wares. We have pandered to the public taste by bringing out new funds to capitalize on each new market fad, and we have magnified the problem by heavily advertising the returns earned by our hottest funds.

97 with the total market; and its performance has been virtually identical to that of the Wilshire 5000 Total Equity Market Index over the nearly three full decades in which both indexes have been available. That is not to say the S&P is an easy target for an investor—or even an average index fund manager—to track. Change it does! Indeed in the past 20 years there have been an astonishing 489 changes in the 500 Stock Index. These are not trivial changes; on average during that period, each year has resulted in the addition of stocks accounting for 2.8% of the index’s capitalization—an aggregate two-decade replacement equal to 58% of its value. Typically, these changes are represented by mergers; the few stocks deleted from the index for other reasons typically have very small market caps. In essence, we have a process in which old stocks are deleted from the Index at a rate of about three percent per year, meaning that the weightings of each of the other holdings is reduced by about three percent per year.the

In short, these key decisions will impact your investment performance, leading to the realization that costs truly matter. This concept must take its proper place as a high priority, not merely an afterthought, in an investor’s decision-making process. The solution, then, to the riddle of performance attribution that I posed at the outset—is performance determined by asset allocation or by cost—becomes very simple: realize that costs truly matter. Both.

giddy money managers [including, I would add, investors who actively manage their own fund portfolios] are enthralled by the new gadgetry—technology now sits at the center of a speculative frenzy of religious intensity, a financial mania, a bubble.” In the mutual fund arena, turnover of equity fund shares by investors has also soared. In the 1960s and 1970s, liquidations of equity fund shares averaged 9 percent of assets per year; in the late 1990s, the rate has been running at about 36 percent. Put another way, the holding ______________________ 1“Technology, Transactions Costs, and Investor Welfare,” Professor Lynn A. Stout, Washington University Law Review, 1997. period of the average fund shareholder has tumbled from eleven years in the earlier era to slightly more than three years currently. Just three years. Mutual fund shareholders are using the best medium ever designed for long-term investing for the purpose of short-term speculation. And they will be the losers.

Heck, ask the finance professors here at the University of Virginia (who are probably indexers themselves). Let’s face it: the jury is in. The verdict is: Index! (I leave the proportion in stock and bond index funds to your own good judgment; surely some of each.) We’d best take the problems I’ve outlined today seriously, for we must solve them if our nation’s citizen-investors are to be blessed by the promises of our Declaration of Independence— “the right to life, liberty, and the pursuit of happiness”—and of our Constitution—“to promote the general welfare . . .” Fixing today’s CEO-centric corporate world, eliminating the excesses of the financial system, and repairing the faltering mutual fund industry—returning control from managers to owners in a new fiduciary society—is on the way. I hope my book will give it a good push. But whether it comes about through laws and regulations, or by the wisdom finally acquired by crowds of investors making intelligent investment decisions as they simply seek to further their own economic interests, so it will be. That conclusion reflects my lifelong idealism, and it remains my ideal today.

The table below shows the TCI of the 14 largest equity and total return funds in the UK compared with FSEF and how their TCI differs from their OCF: OCF % Transaction Costs % TCI % % Additional Costs Fundsmith Sustainable Equity Fund 1.05 0.04 1.09 4 Invesco Global Targeted Returns 0.87 0.43 1.30 49 Baillie Gifford Diversified Growth 0.77 0.50 1.27 65 Lindsell Train UK Equity 0.65 0.09 0.74 14 Stewart Investors Asia Pacific Leaders 0.88 0.16 1.04 18 BNY Mellon Real Return 0.80 0.20 1.00 25 Invesco High Income 0.92 0.15 1.07 16 BNY Mellon Global Income 0.80 0.07 0.87 9 Liontrust Special Situations 0.89 0.18 1.07 20 Artemis Income 0.80 0.12 0.92 15 ASI Global Absolute Return Strategies 0.90 0.15 1.05 17 Jupiter European 1.02 0.06 1.08 6 LF Ruffer Absolute Return 1.22 0.35 1.57 29 Baillie Gifford Managed 0.42 0.05 0.47 12 Threadneedle UK Equity Income 0.82 0.05 0.87 6 Average 0.85 0.17 1.03 20 Source: Financial Express Analytics/Fundsmith as at 6.1.20, funds in descending order of size, primary share class. We are pleased that FSEF’s TCI is not only just 4% above our OCF when transaction costs are taken into account, but that this is the lowest increase in the group.you

The characteristics of those who do so will be individuality, training, experience, savvy, determination, contrarianism (or sheer iconoclasm), and hard work. The Puritan Ethic is not all bad! Importantly, they will limit the assets of the funds they manage relative to the market cap of the asset class in which they utilize their expertise, and relative to their proclivity to actively trade the portfolio rather than analyze, buy, and hold. Some successful managers, rather than being concerned with short-term relative risks, will run fully invested equity positions to capitalize on the fundamental long-term opportunities of equity investing. Others will succeed simply by investing with the courage of their convictions, rather than slavishly relying on short-term standards, and holding cash reserves when they judge market risk as excessive. Both groups will manage their funds at reasonable costs, allocating their fee revenues toward human talent and investment productivity, rather than engaging in marketing profligacy designed not to improve investment returns for fund shareholders, but solely to advance the manager’s own profitability.

Indeed, while investment costs of 3% during 1984-2000 (with average fund costs at higher levels than in the 1950s, ‘60s, and ‘70s) reduced the stock market return of 16% for that period to 13% for the average fund, the average fund investor earned just 5%. How was that shortfall possible? First, because investors were victimized by unfortunate market timing, making modest purchases of equity fund shares when stock prices were cheap during the early years of the period and then making huge purchases when prices were dear as the bubble inflated during the later years. Second, because of adverse fund selection, as investors poured their savings into technology funds and tech-oriented growth funds and pulled them out of value funds at precisely the wrong time, with most of their dollars goings into existing funds with the hottest records of performance and new funds that promised full participation in the “exciting Information Age” that supposedly was before us. To regain the faith of equity investors, the mutual fund industry must face up to the obvious issue of excessive costs.tumble

A Better Solution: Tax-Managed Funds In any event, in 1994 at least one fund group, interested in improving the tax efficiency of conventional index funds, developed a series oflow-cost "tax-managed" funds. The most popular form is based on: • A growth stock index (emphasizing lower-yielding equities in order to minimize the tax burden on income). • Realizing losses, to the extent possible, on the sale of portfolio holdings that have declined in order to offset realized gains. • Replacing the holdings sold at a loss after 30 days (engendering some very small lack of precision in matching the index). • Minimizing the possibility of abrupt share redemptions by charging a penalty transaction fee-payable to the fund and its remaining shareholders-if shares are redeemed within five years of purchase. So far, this system seems to be working well. Redemptions are a tiny fraction of industry norms, and speculative "market-timing" short-term investors have been conspicuous by their absence.

 We must give shareholders a higher share of market returns, by slashing the frictional costs of fund investing—management fees, sales charges, operating expenses, turnover costs.  We must recognize that past financial market returns can’t be interpreted as actuarial tables and realize that uncertainty is the ultimate reality of investing. In our great focus on emphasizing the probabilities of reward, we must never let our investors ignore the consequences of loss.  And we must restore a proper balance between stewardship and salesmanship. Summing it all up, by managing their assets in the most honest, efficient, and economical way possible, we must give our clients a fair shake. If we do only that, the age of mutual fund dominance is not only not over, it is just beginning.

respectively. The brute fact: All-in fund costs have consumed about one-third of the annual investment returns earned by their bogeys, even after the benchmarks are adjusted for estimated index fund expenses and taxes. Alas for the fund shareholder, that’s the least of it. Even as we have the famously accretive magic of compounding of investment returns, so we have subtly decretive tyranny of compounding investment costs. Result: the cumulative investment returns earned by mutual funds over the past 15 years have been a pale shadow of the cumulative returns by comparable market indexes: Large-cap funds have provided 51% of the cumulative after-tax profit generated by the S&P 500 Index: Mid-cap funds have provided 37% of the profit generated by the S&P 400 Mid-Cap Index. Small–cap fund have provided 56% of return generated by the Russell 2000 Small Cap Index. That’s just not good enough. Large-cap 15.0% 12.2% $ 81,400 $ 56,200 Pre-tax After-tax S&P 500 17.9 16.7 118,200 101,400 Mid-cap 12.8% 9.8% $ 60,900 $ 40,600 S&P 400 17.5 16.0 112,300 92,700 Small-cap 10.2% 7.5% $ 42,900 $ 29,600 Russell 2000 12.2 10.5 56,200 44,700 Mutual Funds are Meeting the Reasonable Expectations of Investors Fund Type The Cost of Cost* 49% 63% 44% Myth #5: Pre-tax After-tax 15 Year Returns on $10,000 Investment - Blend Funds vs. Index Funds *Appreciation of active fund investment as % of index fund. Fund returns adjusted for survivor bias of 0.3, 1.2 and 2.0 percent, respectively.

public and private pension funds had just 42% of assets invested in equities at the start of the great bull market in 1982, but 63% at the March 2000 high. Hardly a winning timing strategy! So the simple wisdom of holding a balanced index fund with a fixed bond-stock ratio, for individuals and institutions alike, seems yet another winning long-term investment strategy. The record, then, is clear: the wisdom of investment has resulted in a clean sweep for stock, bond, and balanced index funds alike. The Wisdom of Balanced Indexing Growth of $1,000,000: 1986 - Oct. 2001 $1.0 $2.0 $3.0 $4.0 $5.0 Balanced Index Avg. Balanced Fund Millions Avg. Ann. Return: Bal. Index: 10.9% Avg. Fund: 9.2% $4.6 $3.7

To state the obvious, investing for income is a long-term strategy and investing for capital gains is a short-term strategy. (The turnover of dividend-paying stocks is one-half the turnover of non-dividend paying stocks.) Investing for growth, as Lord Keynes reminded us, is all about speculation on price, while investing for income is the heart of “enterprise,” the word Keynes chose to describe the long-term yield on any investment. Things haven’t changed much: way back in 1936, he said that “In one of the greatest investment markets in the world, namely, New York, it is rare for an American to ‘invest for income,’ and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that he is attaching his hopes to a favorable change in the conventional basis of valuation, i.e., that he is a speculator. But the position is serious when enterprise becomes a mere bubble on a whirlpool of speculation.When

But millions of investors require guidance. If you do, you can use either registered advisers or brokerage account executives, and some good ones are available at a fair price. Select them with care! Good advisers give you their personal attention, help you avoid some of the pitfalls of investing, and provide worthwhile asset allocation and fund selection services. But, like any of us, they must earn their keep, providing services of sufficient value to you to make it worth your while to invest through them. You should know exactly how much their services will cost. But I do not believe that they can pick, in advance, the top performing managers-no one can!-and I'd avoid those who make extravagant claims of future performance. How much does it cost? "Fee-only" investment advisers. Their brokerage firms usually charge an annual fee beginning at 1% of assets. Typically, they charge sales commissions of 6% or more on fund purchases--okay for a long-term investor, but devastating if you hold your shares for short periods and switch funds around. (A bad idea, anyway!)

“This golden age for equities won’t last forever . . . but the mean for equities is probably somewhat higher than in the past, and famine will follow feast as it always has.” This firm concluded that the new mean market return would be, “7%-8% real, but below the 10% today’s bulls talk about. The real returns of around 12% generated for a decade now are simply not sustainable. Over time, returns will have to gravitate back toward the new mean.” If—if—this is so, the strategy bulletin seems to imply, stocks at today’s levels are overvalued (i.e., overpriced relative to the fundamentals) by about 20%. In such an environment of revaluation, we would face a protracted period with real stock returns in the 3%-5% range. Stocks, then, would face serious competition from bonds. For bonds, based on today’s yields, should provide returns of about 3 ½%-4% on average over the coming decade, at considerably lower risk. Given the hazardous nature of market forecasting, however, and the powerful odds against being right twice (selling at or near the highs, and buying back at or near the lows, a winning strategy of extraordinary unlikelihood), the possibility— even the probability—of inferior risk-adjusted returns on stocks should not be sufficient, in my judgment, to cause long-term investors to abandon stocks in their entirety.

Add to that list fair-dealing, not only fair prices and fair limitations on how and when and in what portfolios clients may invest, but focusing our energies on activities that serve clients— management, investing, administration, financial controls—rather than those that do not, such as marketing and peripheral business ventures. If we truly respect the human beings who are our clients, they will come to entrust us with the stewardship—a word too seldom used in this industry today—of their hard-earned assets. Placing service to the human beings who are our clients at the top of our priority list is easily said. It may even seem obvious, although rare indeed does the phrase “human beings” appear in a book on corporate strategy, or on competitive advantage, or even “killer applications.” But I confess that back when Vanguard began a quarter-century ago, I never thought very deeply about human beings as the central focus of our corporate strategy. Nonetheless, for as long as I can remember, I’ve held high the ideal of respecting all of the souls one meets along the long and winding road of life—from the highest in rank to the humblest—with respect, decency, and kindness. This spirit must not encompass only clients, but crewmembers as well, and with equal fervor.

Another reason for such forbearance is conflict of interest. While such conflicts are regularly denied, it is easy to imagine that private institutional managers would be reluctant to vote against the entrenched corporate managements that have hired them to manage most of the more-than-$2 trillion of equities in their pension plans and 401-k thrift plans. But that’s only the beginning of the problem. While the votes of the mutual funds in a company’s thrift plan presumably must be voted as a whole, the corporation itself could direct its pension managers to vote the shares of the corporations held in its pension plan in any way it wished. But it doesn’t take a lot of imagination to realize that corporations, too, are unlikely candidates for aggressively voting the shares their pension plans hold in other corporations. Why be known as a trouble-maker among your Business Council colleagues? So, whether tacit or explicit, a system has emerged in which “let he who is without sin cast the first stone” has become the watchword of behavior for corporations that control trillions of dollars worth of shares of other corporations—a sort of American Keiretsu. Further, of course, passivity in governance pays. Let others undertake the hard work and costs of activism. If their efforts are successful, the passive-ists—holding, say, the remaining 95% to 99% of shares, will not only reap the rewards, but increase their chances of getting the pension and thrift business of the activists.

It provides a rough guide to how much risk the fund typically assumes relative to its objective group and relative to all equity funds. There are marked differences from one style to another, reflected in the finding that, generally speaking, value funds carry distinctly less risk than growth funds, and large cap funds carry less risk than small cap funds.profiles:

After all, the median holding of a mutual shareholder is less than $5,000 and an account of that size would generate about only $80 in annual revenues for the average fund manager, and, given our low costs, a minuscule $12.50 for Vanguard. Clearly, those revenues couldn’t possibly justify a substantial commitment to personal service for the typical investor. But we do make an effort to provide special services designed to expand and deepen our relationships with our investors, and technology has played a major role in accessing our account database. As in all businesses, a relatively small number of relatively large clients are responsible for a high portion of our business, and our most desirable clients are those with the largest investment balances and the longest and strongest relationships with us. While our objective is old-fashioned—using enhanced services to retain clients, all the while keeping costs under control—the technology used in this pursuit is new. Electronic wizardry has allowed us both to mine our shareholder database for those clients and then to more effectively manage those relationships.

The Triumph of Indexing Through the intellectual inspiration of Lord Keynes and the brilliance, moral support, and friendship of Dr. Samuelson—and huge amounts of good luck!—the simple logic and elementary mathematics of indexing are beginning to reshape the way investors think about the financial markets that confront us today. They are a mess! The folly of short-term speculation has crowded out the wisdom of long-term investing, giving us a financial system in which millions of investors have lost their trust. Indexing has become the counterculture to the speculative culture that has shaped our markets in the recent era.Sir

Perhaps, once again, our society and our economy will continue to reflect the resilience that they have demonstrated in the past, often against all odds. And perhaps we’ll come to our collective senses and develop the courage to take arms against this sea of troubles that I’ve described today, and by opposing, end them. If we do, the stock market will undoubtedly respond and resume the upward course that is based on the intrinsic economic value of business growth. Let me close on a more constructive note. Of course our markets need “financial entrepreneurs,” traders, and short-term speculators, “risk-takers restlessly searching to exploit anomalies and imperfections in the market for profitable advantage.” Equally certain, our markets need “financial conservatives,” long-term investors who “hold in high esteem the traditional values of prudence, stability, safety, and soundness.”2 In my judgment, letting that balance get out of hand bears a heavy responsibility for today’s turbulence and uncertainty. 2 The quotations are from Dr. Kaufman’s book, page 304.

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; you will see it perhaps often in this history; for even if I could conceive that I had completely overcome it, I should probably be proud of my humility. If, in the history I have recounted today, I have allowed my own pride to peep out and show itself, I assure you that it is with great humility that I accept the award of the Benjamin Franklin Founder Bowl with which you honor me.

Whatever the case, that return may well be reduced by several percentage points per year by emotions, reflected in a p/e ratio that moves lower over, say, the next decade. If so, the return on stocks would be, say 5% or 6%. Maybe it will be better, maybe worse, but future returns are likely to be shaped largely by the underlying economics of business, not by the unpredictable emotions of investors. To complicate things, the threat of terror and the war on terrorism had made the economics of American business less clear than usual. Earnings will be down sharply this year, and next year is anyone’s guess. But the truly long-term investor can reasonably expect that corporate earnings are likely to be at least somewhat higher in 2005, and almost certain to be much higher in 2010.Course

And so it was that after the spring of hope a year ago, we have now completed a summer, a fall, and a winter of, if not despair, surely disappointment. We await the next season. What does it hold for investors? The Sources of Stock Market Returns With apologies to Dickens, I turn again to a tale of two markets . . . but a tale of two other markets: Stock markets past, and stock markets yet-to-come. Do we have everything before us, or nothing before us? To answer that question, we must look at the U.S. stock market in total, well-represented by the Standard & Poor’s 500 Stock Index, which includes both listed stocks (now 85% of its value) and Nasdaq stocks (15%). Let’s begin with the eternal mathematics of the stock market, in which returns are derived from two distinct elements: Investment, and speculation. Investment return is represented by the sum of a stock’s dividend yield plus the rate of its earnings growth: It tends to be steady, recurrent, and almost always positive. Speculative return is measured by the willingness of investors to pay more—or less—for each dollar of earnings: It is intermittent, spasmodic, and may as easily be negative (a falling price-earnings ratio) as positive (a rising price/earning ratio). Simply adding the two elements together gives us the total market return. But over the long run, it is investment return—earnings and dividends—that calls the market’s tune.

It is as hard to imagine fund directors basking in the glory of this record of their stewardship as it is easy to imagine their general concern, even their embarrassment, although there is no evidence of either. So it is easiest of all to imagine that the fund directors unaffiliated with fund management are completely unaware of these facts. (To be sure, their affiliated director counterparts must be all too aware of them). Yes, I’m reasonably confident that nearly all directors receive presentations showing returns on an annual basis and a cumulative annualized basis, but I wonder how many boards are exposed to cumulative after-tax returns on a comprehensive comparative basis. Yet despite what the data shows, we have virtually no examples of the termination of contracts of fund managers primarily by reason of consistent inferior performance. That strongly suggests that directors either don’t know, or don’t care, or don’t think it is their role to take action. If they don’t know, they are derelict in their duty. If they don’t care, they are financially illiterate. And if they don’t think their role is to take action, who else do they think will fulfill that role? Where Do We Go From Here?

of the early 19th century, “the greatest enemy of a good plan is the dream of a perfect plan.” Put your dreams away, I would warn investors, and stick to the good plan represented by the classic index fund. What Would Benjamin Graham Have Thought About Indexing? So of course I’m troubled by this era’s focus on what I regard as potentially counterproductive investment strategies. In writing in my Little Book about these truths about how our financial system actually works, why classic indexing is the ultimate winning strategy, and puzzling over the trading index funds is—so popular and whether there are new “paradigms” that assure beating the market from now till doomsday, I mused about what the legendary Benjamin Graham might have thought about these developments. I’d studied his wonderful book The Intelligent Investor, published in 1949, and decided to see what I could discover. Although Graham is best known by far for his focus on the kind of value investing represented by the category of stocks he describes as “bargain issues,” he cautioned, “the aggressive investor must have a considerable knowledge of security values—enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise . . . It follows from this reasoning that the majority of security owners should elect the defensive classification.” Why?

The special services we provide to our client households with $250,000 to $1,000,000 or more invested at Vanguard include a designated and experienced phone representative (or team) who provides continuity, account familiarity, and (in the words of The Economist article that I cited earlier) an ability to do “a little extra when they judge it right to do so.” While the 400,000 households that qualify represent only about 5% of our investor population, they hold nearly $200 billion of our shares—fully 60% of our $320 billion of shares held by individuals. (We categorize the remaining $230 billion as institutional, fund shares largely owned through retirement and thrift plans.) These Flagship and Voyager investors are among our most loyal and satisfied owners. We push technology as far as we can to personalize these services. We hold e-meetings, and send e-mail which discusses changing markets and changing investment expectations. We have begun a program of collaborative browsing, in which both client and Vanguard representative have the same data before them on the computer screen. They can readily discuss the status of the accounts, consider the implications of changing fund holdings, and provide some reassurance, when appropriate, about staying the course. Technology has also enabled us to create more favorable prices for our largest and most durable clients.

 Our original index fund is now the world’s largest mutual fund, and our panoply of stock index funds total $180 billion. Our market share of no-load stock index fund assets is a dominant 82%.  Our original troika of tax-exempt bond funds, and the similarly-structured taxable bond funds that followed—all relying on index-like strategies—total $112 billion in assets, including $24 billion in bond index funds. Market share: Now 45%, vs. 18% in 1980.  Our money market funds, also capitalizing on the low-cost-equals-high- return equation have assets totaling $93 billion. Market share: 33%, vs. 4% two decades earlier.  And the assets of our traditional actively-managed equity funds total $144 billion. Market share: 15% down from 25%, the inevitable result of our focus on indexing. The magnificent returns in the financial markets—stock, bond, money market—through most of our history, really right up to the spring of 2000, have given HMS Vanguard a powerful wind at her back. Our assets have grown at a compound rate of 25% per year, and at a remarkably steady pace, carrying our asset base from $1 billion to $565 billion. But the overwhelming portion of that huge increase has come from our rising share of market. Had our share held steady, our assets today would be $110 billion. The remaining $455 billion is accounted for by the increase of our share of total industry assets from 1.7% in 1981 to 8.3% today—without a single year of decline.

The Folly of Speculation This wisdom of investment has been the powerful engine that has driven indexing to its position of dominance in institutional and individual portfolios today. That wisdom continues to dominate indexing in public and private plans. But in the mutual fund industry—now responsible for 41% of total indexed assets compared to just 3% in 1990—change is in the air. Most of the growth of indexing during recent years has been based, less on the wisdom of investment, than on the folly of speculation. This speculation is based in part on the idea that betting on particular market sectors—say, technology or growth or small-cap or emerging markets—will enable investors to outperform the market for a time. The fund industry has helped to foster this trend not only by forming hundreds of actively-managed technology and aggressive growth funds, but also by offering index funds that focus on relatively narrow market segments. The speculation is also based on the offering of funds that, while they own broad stock market indexes, enable and indeed encourage market timers and traders to opportunistically trade the index in, as it is said, real time. While it has not been fully recognized, the development of speculative index funds is a major trend. As recently as 1998, assets of market segment funds and exchange-traded-funds (ETFs) totaled $50 billion, just 25% of the $195 billion assets of the traditional S&P 500 and all- market index mutual funds.

Nonetheless, I freely concede that technology has served fund shareholders extremely well in one sense: The unit costs of fund share transactions and fund portfolio transactions have sharply declined. Indeed, their decline has already helped to reduce the costs of operating mutual funds. Computer costs have plummeted by almost 99 percent, from $150,000 per million instructions per second (MIPS) in 1985 to perhaps $1,000 per MIPS today. The cost of a personal telephone response was $10 in 1985; today, it is only $2 for an automated telephone response (a bit discomforting for many investors). When a printed fund prospectus is delivered, the cost is $8; when the same prospectus is delivered over the Internet, the cost is essentially zero. Fund transactions can be electronically implemented and processed by pushing just a few keys on a personal computer—a further huge savings. It was recently estimated that some 30 million of 50 million fund investors have home computers, with 10 million using them in investing. (Another estimate suggests that 30 percent of fund shareholders in the largest mutual fund casino—my word for the mutual fund supermarkets where trading fund shares is at least tacitly encouraged—already handle their transactions in its website.) Today’s 10 million users will soon become 15 million and then 20 million, and they will all have the ability to redeem their shares at a moment’s notice.

When Vanguard’s maiden voyage began—almost from ground zero, with just 28 crewmembers—it occurred to me that, in a fiercely competitive field, there was only one way we would ever accomplish our novel and challenging mission: Together.

accordingly. If the fund industry doesn’t wish to recognize the need for these changes and reduce its embedded alpha, it is only a matter of time until investors will recognize it—and they will vote with their feet. Yes, as the theme of this conference indicates, the economics of wealth are a ‘changing. But it’s more than economics. Investors’ faith in their fund trustees has been shaken even more emphatically by the fact that fund managers have moved away from being prudent guardians of their shareholders’ resources and toward being imprudent promoters of their own wares. We pander to the public taste by bringing out new funds to capitalize on each new market fad, and we magnify the problem by heavily advertising the returns earned by our hottest funds. The first step in restoring the investing public’s faith is to focus far less on salesmanship and far more on stewardship. If we simply put our clients first, just imagine how well we can serve investors in the New Era. Looking Ahead In the New Era for wealth management we are facing, restoring faith must be at the top of the agenda. We have to present to our clients realistic expectations for future returns, and emphasize that while emotions can overwhelm economics in the short run—sometimes for the better, sometimes for the worse— in the long run, it is the fundamental economics of the stock and bond markets that carry the day.

You should know that there are lots of hidden loads out there. 12b-l Fees. Even some apparently no-load funds have sales charges known as 12b-1 fees that are deducted from your returns each year. These fees are used to promote a fund's sale by aggressive advertising and marketing programs. The fund shareholders pay the freight, but they receive no benefit whatsoever in return. Caveat emptor of 12b-l fees! There is still one final cost you must understand. "Funds of funds" and "wrap accounts". These fund-pickers charge additional annual fees of up to 2% over and above those paid by the underlying funds. Don't go there-eategorically. The fact is that there is no there there. It's just too expensive a package. Combined costs of up 4% a year simply destroy even the most remote chance you have of reaching 100% of the market's return. Too much dead weight. My third rule comes to grips with the first element that catches the eye of most investors whether experienced or novice-the fund's past "track record." (The implied analogy to a horse race is presumably unintentional!) But track records, helpful as they may be in appraising how thoroughbred horses will run, are usually hopelessly misleading in helping you appraise how money managers will perform. There is simply no way under the sun to forecast a fund's future returns based on its past record. Rule 3. Do Not Overrate Past Fund Performance. Now, I must contradict myself ever so slightly.

Large Medium Small Blend Growth Value Morningstar Risk Profile, June 1998 B. Risk (Average Fund = 100) I should note that while, over time, relative fund returns vary randomly from one period to the next, relative fund risks carry a healthy degree of consistency. So, especially in these volatile, care-laden days, ignore risk at your peril. And while you’re looking at that plethora of numbers, please don’t forget there is more to fund selection than numbers. To me, the character, integrity, stability, and judgment of a fund’s management are the qualities on which your dream of the perfect plan should rely. In all of your searching for the quantities that describe investment returns, I urge you not to ignore the qualities of those who will be the stewards of your precious assets. Rule 8. Consider the Implications of Asset Size Any investor seeking the perfect plan must be aware of asset size and its implications for the future returns of the funds selected. By far the biggest problem is that investors seeking extraordinary future returns focus on extraordinary past returns, frequently accomplished when a fund was small. Such returns are simply not repeatable; indeed they may not even be honest.

the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” More reliance on dividends should mean less reliance on earnings. Lest we forget, dividends are “real,” in contrast to those illusory earnings per share that are manufactured each quarter, under generally accepted accounting principles that, even if honestly administered, depend on myriad estimates of things unknown. The focus on corporate earnings above all else bears much of the responsibility for our highly leveraged balance sheets, for unwise capital commitments, for mergers done solely for financial reasons and bereft of a business rationale, and for that misbegotten financial engineering that was a triumph of form over substance. Dividends, on the other hand, remind us that “cash is king,” and calls the tune for long-term returns. A return of dividends to their formerly high standing on the agenda of stockowners would do much to reduce today’s high turnover and excessive speculation. As the focal point of a two-way communication channel—from management to shareholders and security analysts, and vice versa—you Investor Relations executives have a key role to play in all of these areas. The cooperation between owners and managers that I call for today will require not only a more active use of this two-way channel, but a more open use.

past six years, Microsoft, Cisco, and Intel, for example, would have apparently represented, not the 4.9%, 2.8%, and 2.3% of the Index that they represented as 2000 began, but 5.5%, 3.2%, and 2.5%. While these are not to be taken as hard numbers, they do suggest that a strategy of gradually selling winners may have helped to marginally improve the performance of the index. Active managers may want to take note. No similar adjustments are required in the Wilshire 5000 Total Stock Market Index, which includes not only the large-cap stocks in the S&P 500, but mid- and small-cap stocks as well. Yet despite modest short-term variations, it has tracked the S&P 500, as I noted, with virtual perfection over the long-term. Stocks normally come into the index when they are very small and there is no reason to remove them when they hit an arbitrary size. And they are held forever . . . or at least until they are merged into another corporation. It is largely for these reasons that I favor the all-market index fund as the best choice for most investors. “Benchmarking” The compelling data I’ve presented shows a substantial shortfall in the long-term returns of mutual funds despite cost and tax assumptions that are remarkably conservative. I’ve also assumed that domestic funds as a group can be fairly compared with the S&P 500 Stock Index, which closely tracks the total U.S. stock market.

Still, the case for a balanced stock/bond program—rather than an all-equity program—seems to me to be even stronger today than at most times during the past quarter century. 4. The Implications of RTM for Investors So far, I’ve emphasized the academic aspects of RTM—what the historical statistics tell us. I believe it is clear that mean reversion is alive and well. It is manifested in almost every aspect of investing: in shaping relative returns for individual mutual funds; in shaping the relative performance of diverse market segments; and in determining the absolute levels of long term returns (albeit perhaps at a prospective level that is slightly higher than in the past) of equity prices as well. If, as an academic matter, you accept this thesis, what actions does it imply for the wholly pragmatic business of investing? How can this history help you to assure yourself and your family with the optimal opportunity to amass a capital fund for retirement? It is to this question that I now respond. First, as to asset allocation. While the financial markets today seem to me to carry a higher than normal risk component, I do not believe you should consider abandoning equities in your retirement plan. Rather, I would suggest continuing to balance the potential risks and returns by centering on a 70% equity/30% bond program. I’d shade equities higher (up to 85/15) for those at the beginning of their 4 Morgan Stanley, February 24, 1997.

In short, to be successful in a world in which indexing and quantitative strategies will become increasingly pervasive—and fully competitive—the successful traditional investment manager must serve the client’s interest . . . first, last, solely. To conclude, I rely again on Charles Dickens, this time in A Tale of Two Cities: “It was the best of times. It was the worst of times.” It has been the best of times for the stock market, a 15-year bull market of unprecedented magnitude, creating happiness beyond measure. But it also has been the worst of times (though it is hardly perceived as that . . . yet), creating misery for the average mutual fund manager, who has lagged the S&P 500 Index by an unprecedented annual margin of nearly three percentage points—surely less than a ringing tribute to professional management. Looking ahead to a new century, the mutual fund industry must be challenged to serve its clients much more effectively.

This focus on marketing has also had a profound negative impact on fund investors, who have paid a huge penalty both in the timing of their fund purchases and in the selection of funds they purchased. Result: mutual fund owners have fared far worse than the funds themselves.

More recently, others in the industry have begun to respond, and six new purportedly tax-managed funds have been formed during the past year. But none follow an index strategy, and none, so far as I know, have taken steps to limit redemptions. Overall, save their "leaning against the wind" to avoid excessive turnover, their investment objectives seem to be conventional, as are their expense structures. Further, it is not clear what will happen when they experience the inevitable portfolio manager turnover. These limitations, in my view, will make it difficult for them to reduce either the tax bite or the bite that operating expense ratios take out of Alpha. Properly structured, however, the tax-managed fund is, I believe, destined to become a strong force in the mutual fund field, made even stronger, I believe, by the reduction of taxes in the 1997 Tax Reform Act. Under previous law, the 28% capital gains rate was 12% below the 40% maximum marginal income tax rate. The new rate is 20%, or 20% below the 40% income tax rate. This change raises the long-term "tax discount" from 12% to 20o/o-fully 1.7 times. In addition, the Act has given a lesser relative advantage to gains on securities held for 12 to 18 months (28% tax), reducing the benefits of the new lower rate to high turnover mutual funds. In all, a soundly-structured low-cost tax-managed fund should be the best way to take most of the sting out of a negative Alpha.

Thus, the decision to remain silent becomes what is called—I don’t much care for the expression—a “win-win” decision. So it is that most corporate activism has been left to TIAA-CREF and to the state and local government pension funds. There are 13 such funds in the Institutional 100, directly managing in-house some $220 billion of equities. (Labor unions are also active in promoting reform, but even in the aggregate, their assets are relatively small). These owners can play a far larger role than their size would indicate. For while mutual funds and pension funds have rarely initiated reform proposals, they have on at least some occasions been willing to support proposals initiated by others. If the activists succeed in getting well-articulated proposals with demonstrable benefits into corporate proxies, support from otherwise passive private institutional managers could easily follow.

The belief that technology companies would continue to soar captured the mind of many inexperienced investors. One fund manager even wrote a book describing why he had cast his vote with the crowd, assuring his readers that his funds had jumped aboard the fast-moving large-cap, high-growth, high-tech bandwagon. He applied his new strategy to the equity funds he managed, and his aggressive growth fund leaped by 82% during the two years through the first quarter of 2000. His moderate growth equity fund rose 51% during the same period. That performance was nonetheless insufficient to give him a victory in a bet I’d made with him that an index fund would do better during the five years ended March 31, 2000.points--+226%

Consider the past 40 years: Dividend yield plus earnings growth came to a total of 11.2% per year. The actual return of the stock market came to an identical 11.2%. 0.1 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 Investment Return vs. Market Return: 1961 - 2001 Investment Return 11.2%/year Market Return 11.2%/year

In his brilliant 2001 memoir, On Money and Markets, the economist/investor Henry Kaufman, one of the wisest of all the wise men in Wall Street’s long history, shared my concerns, expressing his own fears about the globalization of finance, the derivatives revolution, the corporatization of Wall Street, the limits on the power of policy makers, and the transformation of the character of our markets. In his final chapter, he summarizes his concerns: Trust is the cornerstone of most relationships in life. Financial institutions and markets must rest on a foundation of trust as well. . . . Unfettered financial entrepreneurship can become excessive and damaging as well-leading to serious abuses and the trampling of the basic laws and morals of the financial system. Such abuses weaken a nation’s financial structure and undermine public confidence in the financial community. . . . Only by improving the balance between entrepreneurial innovation and more traditional values can we improve the ratio of benefits to costs in our economic system. . . Regulators and leaders of financial institutions must be the most diligent of all. Together, participants in our financial markets must work together to restore that balance, and return financial conservatism to its rightful pre-eminence. For as Lord Keynes wrote all those years ago, “When enterprise becomes a mere bubble on a whirlpool of speculation, the job of capitalism will be ill-done.

lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. I think the above table speaks for itself in terms of the relative performance of our Fund so that you can look not just at the fees and costs but what you get in return — performance. The Fund’s performance for the year was adversely affected by a couple of poor months in September and October which cost the Fund about 6%. This was caused by two factors: 1) a rally in the sterling exchange rate from the recent lows which it had plumbed after the Brexit referendum result in 2016 and on subsequent hard Brexit fears; and 2) a ‘rotation’ from the high quality and relatively highly rated stocks of the sort which our Fund owns into lower quality and more lowly rated ‘value’ stocks. If you read the breathless commentary on this in much of the press without knowing the actual performance of our Fund you might be surprised to find that, notwithstanding these events, it ended the year up by 23.4% which was our best year since inception and outperformed the MSCI World Index by 0.7%. Taking each of these factors in turn, currency movements clearly have some effect on our portfolio. Over 58% of our portfolio is invested in companies listed in the United States. The actual exposure to the US dollar and therefore the pound/dollar exchange rate is better gauged by the c.

William of Occam. Writing 700 years ago, he postulated that when there are multiple solutions to a problem, the simplest choice is the best. “Occam’s Razor” has proved itself in many areas of intellectual focus, and it has surely done so in the world of investing. Indexing is now a major force in investing. Today it represents about 25 percent of the assets of America’s $5 trillion in pension assets, and almost 30 percent of the $6 trillion assets of our equity mutual funds. (Chart 4) Those percentages are bound to grow. Over the past five years alone, for example, more than $500 billion of investor dollars have poured into equity index funds, while $370 billion has been cashed out of active-managed funds. (Chart 5) This difference offers nearly $1 trillion worth of proof that investors are starting to “get it.” And the final triumph is yet to come. Equity Index Fund Market Share 0% 5% 10% 15% 20% 25% 30% 1992 1996 2000 2004 2008 2012 3% 5% 10% 14% 20% 28% Equity Fund Cash Flow Since 2008 Index funds have taken in over $500 billion; active funds have lost almost $400 billion $136 $83 $108 $93 $98 $518 -209 -5 -7 -86 -63 -370 -500 -400 -300 -200 -100 2008 2009 2010 2011 YTD 2012 2008-12 Index Funds Active Funds $ $ billions

Summing Up Let me close by returning to my original theme of sharing our blessings with others less fortunate, never more so in these days when America’s values—America’s very character—are being challenged. No one is more articulate on this subject than John Gardner, so here are his words, with one small edit to reflect the events of September 11 and thereafter: Today our communities need us, desperately need our loyalty, our understanding, our support . . . This nation is facing a test of character, all the more obvious after the terrorist attack. The test is whether in all the confusion and clash of interest, all the distracting conflicts and cross purposes, all the temptations to self-indulgence and self- exoneration, we have the strength of purpose, the guts, the conviction, the spiritual staying power to build a future worthy of our past. You can help. Yes, you can. Return with me to that poem inspired by a fading stone image of a man and his wife holding hands: What will survive of us is love. Tonight, I ask you to recall that the world-wide symbol of the United Way is itself dominated by a hand, and, not surprisingly, an open hand. It seems to me that that symbolic hand is crying out to be held by a human hand, and then another, and another, then scores, then millions of hands, all across America, all joined in common cause, all in helping one another in acts of devotion to other human beings less fortunate than we are.

vs. +156%.) When I wrote to thank him for sending me the $25 to settle our bet (huge for me!) I expressed my opinion that his new strategy was “fighting the last war”. And so it quickly proved to be. In the year since then, the manager’s two growth funds have plummeted by 45% and 55% respectively, more than double the 22% decline for the index fund. But just because some investors insist on “fighting the last war,” you don’t need to do so yourself. It doesn’t work for very long. Pillar 11. You Rarely, If Ever, Know Something The Market Does Not. If you are worried about the coming bear market, excited about the coming bull market, fearful about the prospect of war, or concerned about the economy, the election, or indeed the state of mankind, in all probability your opinions are already reflected in the market. The financial markets reflect the knowledge, the hopes, the fears, even the greed, of all investors everywhere. It is nearly always unwise to act on insights that you think are your own but are in fact shared by millions of others. Well, here we are again, in the grip of a bear market, and worried about whether it will get worse. No one knows when it will be over. Maybe it is over.

The Penalties of Timing and Selection First, consider the timing penalty. With the Standard and Poor's 500 Index languishing under the 300 level during 1984–1992, investors purchased equity funds at a $10 billion annual rate. But with the index over 1100 in 1999, on the way to its 1527 high in 2000, investors poured money in at a $220 billion annual pace. Putting so little of their money into equity funds in the early years when stocks were cheap, and so much of their money when stocks were dear, has cost fund investors plenty, and the fund industry must share the responsibility for that counterproductive pattern. Chart: The Timing Penalty Investors also paid a huge selection penalty, and here the industry's responsibility is far greater. During the bubble, we created and promoted growth funds and sector funds that favored over-priced NASDAQ stocks—the "new economy," technology, and the internet. At precisely the wrong time, investors poured $460 billion into these highly risky funds and withdrew nearly $100 billion from the conservative value funds favoring NYSE stocks—"old economy" stocks which, bless them, both lagged the market as the bubble inflated and held fairly steady as it burst. Chart: The Selection Penalty The net result of cost-induced performance lag of the average fund, leveraged by the timing penalty and the selection penalty paid by the average fund investor, is truly stunning.

Mutual Funds as Proxy Voters A new development may well inspire mutual funds to join those investors to become more conscious of their responsibilities of corporate citizenship, and to take their voting responsibilities more seriously. Early in 2003, the Securities & Exchange Commission approved a requirement that funds (the “agents”) report to their owners (the “principals”) how their (the owners’) shares were voted in corporate proxies. While such disclosure would seem totally logical, the fund industry brought out its biggest guns to battle the proposal, and even long-time rivals Fidelity and Vanguard joined together in expressing their opposition in a Wall Street Journal op-ed piece signed by their chairmen. (“Politics makes strange bedfellows.”) Despite the opposition, the SEC stood its ground, and in August we’ll learn how each mutual fund voted each of its corporate proxies during the 2004 season. It’s about time, and it will matter. For I believe that the requirement to disclose proxy votes will begin the process of giving mutual funds the motivation to become better corporate citizens. For example, The Vanguard Group, which has traditionally regarded regular voting of proxies as a fiduciary duty, adopted more aggressive proxy voting guidelines in 2003. While the funds had previously endorsed 90% of director slates, last year they ratified all directors in only 29% of the slates, withholding votes from at least one nominee in a stunning 71% of the cases.

If speculative return came, as it did, to zero over the full period, in the short-term, and even over extended periods, it plays a crucial role, beautifully exemplified by dividing that 40- year period into two equal 20-year segments. Both periods saw excellent annual investment returns: 12% during 1961-1981; 10% during 1981-2001. But speculative return subtracted 4½% in the first period and added 5% during the second. Result: a market return of 7½% in the first 20 years, and 15% in the second. Curiously, despite a lower rate of corporate earnings growth and dividends during the second period, the annual return on stocks doubled. Why? Because the price/earnings ratio, which had tumbled from 22 times in 1961 to 8 times in 1981, had returned to 20 times in April 2001 (after reaching an astonishing 32 times at the market high last March). The point is that the economics of market returns—the earnings and dividends of America’s corporations over two centuries—are almost always both predictable and productive. The emotions of market returns, on the other hand—the change in the price that investors are willing to pay for each dollar of earnings—are unpredictable, at times remarkably productive; at other times, remarkably counterproductive. This dramatic example of the two forces that determine stock returns—investment and speculation—helps us look ahead and consider what returns we might expect over the coming decade.

Because “[the majority of investors] do not have the time, or the determination, or the mental equipment to embark upon such investing as a quasi-business. They should therefore be satisfied with the reasonably good return obtainable from a defensive portfolio, and they should stoutly resist the recurrent temptation to increase this return by deviating into other paths.” He noted that Wall Street is “in business to make commissions, and that the way to succeed in business is to give customers what they want, trying hard to make money in a field where they are condemned almost by mathematical law to lose.” (Drop the “almost,” and there is the Gotrocks family!) In The Intelligent Investor, Graham commended the use by investors of leading investment funds as an alternative to creating their own portfolios. Graham described the well- established mutual funds of his era as “competently managed, making fewer mistakes than the typical small investor,” carrying a reasonable expense, and performing a sound function by acquiring and holding an adequately diversified list of common stocks.bluntly

accumulation programs, with a healthy appetite for returns and a strong stomach for risks, and an extended time (15 to 40 years) before retirement. For those making investments that are modest relative to the capital already salted away, with more conservative instincts and shorter time horizons (1 to 15 years), I’d shade equities lower, all the way down to 35/65 at the extreme. For no one knows what future returns the financial markets will provide. Here, I want to emphasize the incredible power of compounding over an extended period of years. Given sufficient time, even a small enhancement to returns is virtually priceless, even if equities fail to provide their historical premium—their excess real return—of 3 1/2% over bonds, as seems highly likely to me. After all, the equity premium has been more than 6% annually during the past decade, and some RTM would hardly be astonishing. But even a 2% risk premium—only about one-half the norm— would make a powerful difference. Exhibit XI shows that a retirement plan program—investing, say, $5,000 regularly, year after year—earning a 5% nominal return would produce $250,000 in 25 years and $634,000 in 40 years, while the same investment at 7% would produce terminal values of $340,000 and $1,068,000, respectively. The modest 2% equity premium adds $90,000 in 25 years, and adds $430,000 in 40 years, itself more than two times the cumulative $200,000 of annual investments. These are hardly trivial differences in capital accumulation.

40% of our portfolio companies’ revenues which are in the USA. However, currency movements are not something we believe we can predict — they seem to have about the same predictability as a game of Snakes & Ladders — or hedge. I would suggest looking at the matter this way: imagine we were in a discussion with some of the companies which have produced great returns for us over the last nine years, or which might do so over the next nine, and we asked them to name the top three factors in their success. What do you think the chances are that they would say ‘currency exposure and exchange rates’? I would suggest they might name product innovation and R&D, strong brands, control of distribution, market share, customer relationships, installed bases of equipment or software, management, successful capital expenditure and acquisitions as far more important. So, we think it’s best to ignore the Snakes & Ladders of currency movements. Turning to the second point — the so-called rotation into value stocks, I am not much of a gardener but I believe this is becoming what gardeners term a hardy perennial as it crops up every year.in

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

Looking Ahead—A Personal Note As we look back over the three adventurous voyages I’ve described this evening, it’s worth speculating about what may lie ahead. For the stock market, the odyssey is destined to continue, but the two easy golden decades we have reveled in are now history, and the voyage will be rougher and slower in the years ahead. For the mutual fund industry, the odyssey is already waning, and its course will—as it must—at last turn away from high-costs and fad- following, back toward our original roots of prudent management and stewardship. And for Vanguard, our fantastic odyssey, which has already helped to change the way people think about investing, will proceed with even greater alacrity in the years ahead. Unless I miss my guess, in the financial markets and the fund industry alike, we’re facing an extended climate of Vanguard weather. After 50 years in this business, the last 27 with the renegade firm I created all those years ago, I close with a few personal reflections. Peter Bernstein was right. It has been no easy task. The road has not always been smooth, and I’ve experienced headaches and heartaches, hopes and fears, delights and disappointments, even triumph and disaster. But, following Kipling’s advice, I’ve treated those two imposters just the same.

Since then, those non-traditional index assets have more than doubled to $115 billion, and now are equal to more than 50% of the $225 billion for the traditional funds. In 1998, $32 billion of investor capital flowed into investment indexing and $13 billion into speculative indexing. But so far in 2001, just $10 billion has flowed into investment indexing—one-third of the 1998 level—while nearly three times as much—$27 billion—has flowed into speculative indexing. This new generation of speculative index funds may well provide a better way to bet on market sectors than owning actively-managed sector funds, or a better way to trade securities and time the market than day-trading in individual stocks. But mark me down as one who is not a betting man, and one who believes that speculation is not only a loser’s game, but a game in which most losers lose big, and many losers lose all. If so, the current trend in which speculative indexing is overwhelming investment indexing is a counterproductive transmogrification of the values that the original index pioneers held high.

Taken together, the shift of industry focus from management to marketing; the rising rate of fund failures; the incredibly short horizons of portfolio managers; the increasing use of funds as vehicles for trading, not investment; and the soaring costs and tax bills; together they have combined to ill-serve fund shareholders and create a clear record of performance inadequacy. What’s to be done? I suggest that independent directors have a major role to play in the resolution of these seemingly intractable problems. After all, who but fund directors are in a position to bring funds into compliance with the clear mandate of the Investment Company Act of 1940: “The national public interest and the interest of investors are adversely affected . . . when investment companies are organized, operated and managed in the interest of investment advisers, rather than in the interest of shareholders . . . or when investment companies are not subjected to adequate independent scrutiny.is

It takes only a moment’s contemplation to imagine what might happen in the financial markets if, say, half of that number responded to a major earthshaking (literally or figuratively) news event. The industry’s old gatekeeper—a busy signal on the telephone—is retiring, for better or worse. Perhaps busy Internet service provider numbers, or even an Internet crash, will “protect” us if the dark day comes, but perhaps not. Honestly, it’s sort of scary. The Report Card Let’s grade each aspect of the technologies currently used in mutual fund investing:  Investment technology: Innovative financial instruments, A+; liquidity, A+; cornucopia of funds, A+; soundness of new funds, C; investment behavior of mangers, D.knowledge,

Nearly a decade ago, we created an Admiral series of funds with a $50,000 minimum holding requirement and lower fees reflecting our economies of scale. On 2000, we began to expand this service to all of our funds, creating, in effect, two classes of shares: the low- cost class for regular investors and a very low-cost class for substantial investors with long holding periods. The Admiral class already totals more than $50 billion.Clients

Only a few weeks ago, for example, the Securities and Exchange Commission censured and fined one fund manager for reporting misleading returns, warning that, “it is wrong to raise shareholder expectations of future gains by advertising future returns when it is highly unlikely those returns can be sustained.” Yet on our television sets and in our newspapers, everyday, we see fund managers hawking past fund records that cannot possibly be sustained. Don’t let yourself be influenced by such advertising.

And fund portfolios, weighted by assets, closely resemble the configuration of the market, with about the same proportions of large-(70%), medium- (22%), and small-cap (8%) stocks as the market itself. Further, over the very long run, the returns of the various investment styles (small-cap vs. large-cap; growth vs. value, etc.) tend to revert to the market mean, with interim variations ironed out over time. I’ve also assumed that the long-run objective of any equity mutual fund, whatever its style, is, at least implicitly, to “beat the market.” (Some funds may hold themselves out as endeavoring to provide a higher “risk- adjusted” return, but I’ll not deal with that issue today.) Composition of the Market vs.Morningstar

Long-term shareholders who engage in candid communication with management, cooperative rather than confrontational, describing what they want from their investment—including what dividends they want—will play a major role in the restoration of owners capitalism. The Restoration of Owners’ Capitalism As James Surowiecki wrote in last week’s New Yorker, “shareholder activism is on the rise.” This year, there are not only 30% more shareholder resolutions and far higher votes in favor of them, but an unprecedented number of actual approvals. However, like our nation, the corporation is a republic controlled by its elected representatives, rather than a democracy, controlled by its citizens directly. So even approvals by shareholders are non-binding. But it’s only a matter of time until investors who want to change managements or restore reasonableness to executive compensation will gain access to corporate proxy statements. And the mere availability of that option will almost surely improve the sensitivity of directors to the interests of the owners. If the owners of corporate America don’t care about these issues, who on earth should care?

We have to press the vested corporate interests to at last realign the interests of the managers with those of the owners, and turn their focus to enhancing, not stock prices, but building corporate values. And our managers— our investment fiduciaries— must get their act together, and focus not on marketing, but on management. It’s all about wealth management, and it’s a tough business. The competition to provide out- of-the ordinary returns to our clients is intense, the odds against doing so long, and the competition to retain current assets and attract new assets fierce. The costs of operations are rising, in no small part because of rapidly changing technology and increased service requirements. And in the new era, the struggle to build the profits of our firms is hardly going to vanish. But the field of wealth management is also a demanding profession. Our guiding principle must be to put the client first in everything we do. But the reality is that the dichotomy between maximizing the returns on our clients’ capital and maximizing the returns on the capital of our own firms—and, so often in this day and age, the returns on the capital of the financial conglomerates which own so many of our wealth management firms—is no mean challenge.profit

That philosophy has been at the core of everything we’ve done since. It’s called loyalty. But however loyalty may be inculcated into a firm’s values and character, the one message that must come through is: Loyalty is not a one-way street. No enterprise, no matter what endeavor it pursues, has any right to ask for loyalty from those who do the hard work required for its success without a reciprocal commitment that the enterprise will offer its own loyalty in return. If an institution is to care for its clients, it must care too about the human beings who assume the responsibility for serving them. The members of the crew are the heart and soul of the enterprise; without their care and effort, the enterprise will fail. Caring—And Caring Deeply In my frequent speeches to our crew, I have often cited this marvelous quotation from Dean Howard M. Johnson, former Chairman of the Massachusetts Institute of Technology, on the need for individual human beings to care for the institutions of which we are a part: “We need people who care about the institution. In an increasingly impersonal world, I have come to believe that a deep sense of caring for the institution is requisite for its success. “The institution must be the object of intense human care and cultivation: even when it errs and stumbles, it must be cared for—by all who own it, all who serve it, all who are served by it, all who govern it. “Caring, we know, is an exacting and demanding business.

A New Idea, Sixty Years Old With all of the high-priced creative and imaginative talent in this industry, I find myself wondering why someone, somewhere, hasn't dreamed up a still better way to enhance after-tax mutual fund returns. Surely the opportunities abound. Let me describe my own idea. I start with a fund that simply buys a large sampling of high quality blue-chip growth stocks, and holds them unless fundamental circumstances change radically. Where, you ask, do we fmd the budding Warren Buffett to manage it? Honestly, I don't know. So, I shift gears. Why not a fund that buys, say the 50 largest stocks in the Standard & Poor's Growth Index universe? (That's nearly 30% of the capitalization of the entire stock market.) Simply hold them "forever" and don't rebalance as prices change. If there is a merger, keep the merged company; if a company is bought for cash, reinvest the proceeds, either in the next largest company or in the fund's other holdings (it probably won't matter which you do); ifit fails and goes out of business, well, just realize that can happen. Then, run the fund at an expense ratio of 20 basis points, just incurring bare-bones operating costs. Minimize exposure to shareholder redemptions with a stiff redemption fee and/or strong limitations on daily liquidity (i.e., open the fund for redemption only, say, on the last day of each quarter). These latter steps will, of course, make it difficult to attract quick-triggered opportunists. That's good!it

Wrapping Up It was Bernard of Chartres who said in the twelfth century that a dwarf standing on the shoulders of a giant may see further than the giant himself.3 And so this plain-thinking, common- sense-reliant mutual fund veteran stood on the shoulders of Lord Keynes and Professor Samuelson in his efforts to cut through the fog surrounding the foxes of Wall Street and focus on the great idea of the hedgehog. The clear message: history often teaches us the wrong lessons about the financial markets. The past, truth told, is rarely prologue to what lies ahead. The real lessons of sound investment strategy depend upon focusing on the sources of stock and bond returns, and minimizing to the nth degree the costs extracted by our bloated investment system. So, my fellow members of The American Philosophical Society, you thoughtful and intelligent movers and shakers of American thought, please think about the implications of indexing for the financial markets in the years ahead. And while you’re about it, consider whether you should rely importantly on indexing in your own investment programs. That’s important too! 3 Perhaps this idea was the inspiration for the acknowledgement by Sir Isaac Newton in 1676 that “If I have seen further, it is by standing on the shoulders of giants.”

Nonetheless, provided only that your asset allocation going into the bear market last March had been set in accordance with (a) your risk tolerance, (b) the years you have remaining to build your investment, (c) your wealth level, and (d) your income needs, you shouldn’t change the allocation. Times of market duress 10. Beware of Fighting the Last War $1.41 $1.53 $2.56 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.Fund

To make his point, Mr. Surowiecki uses the example of the 1956 comedy, “The Solid Gold Cadillac.” Judy Holliday played Laura Partridge, a small investor whose continual harassment of the board finally gets the company to put her on the payroll as its first director of investor relations. She uses the position, however, to organize a shareholder revolt that topples the corrupt CEO. As Surowiecki concludes: “American companies are the most productive and inventive in the world, but a little adult supervision (by the owners) wouldn’t hurt. Laura Partridge had it right a half a century ago: ‘Somebody’s gotta keep an eye on these geniuses.’” That “somebody” must be the owners. For it is shareholder involvement in corporate governance that will be required to return us to owners capitalism, and eradicate the system of managers capitalism that we never should have allowed to come into existence in the first place. It’s high time we all work together to achieve that mission.

Truth told, I look with some bemusement about how far one can take an enterprise with common sense, a few simple ideas, a heavy dose of idealism, a focus on serving human beings, a fantastic crew, and a determination to press on regardless. It’s been a thrill to see a company that offers little more than simple investment philosophy and simple human values become a commercial success, but even more, an artistic $1 $10 $100 $1,000 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Vanguard Assets, 1974 - 2001 (millions) Annual Growth Rate: 24.9% Year-end Assets 25% Trendline $1.4 b $565 b 4.2% 7.9% 8.3% 6.1% 1.2001

independent directors who have the responsibility for careful scrutiny that assures the primacy of those interests. The Ten Commandments You don’t have to tell me how tough a job it will be for this industry to reach that worthy goal. I’ve been doing my best, even in the years before “The Vanguard Experiment” began, but the tangible results are disappointingly few. Vanguard began its thousand mile journey with a single step in 1974, and lots more steps have followed. (Few of you know how arduous and demanding each of those steps have been, and continue to be.) But let me suggest some further steps along the way to meeting the clear—and wholly desirable—mandate of the ‘40 Act. While I wish we could take a giant step—establishing a federal standard of fiduciary for fund directors would be my choice—the fact is that a series of small but deliberate steps is more realistic. So I would propose that we begin by setting down these Ten Commandments for independent directors: 1) Thou Shalt Retain Thy Own Independent Counsel. Recommended by the Securities & Exchange Commission, this step seems so obvious and so essential that it is hard to imagine why it hasn’t been mandatory ever since this industry began in 1924. Just imagine, in any other business, the anomaly of a firm being represented, not by its own counsel, but by counsel for its largest supplier of services, who depends on it for its very existence.

margin is required for any thriving business, no firm that fails to serve its clients first will long endure. The secret of success in wealth management, I think, is simple: We must both make money for our clients, and give them their fair share of whatever returns the financial markets are generous enough to favor us with. We also must recognize our limitations. Wealth management today is a huge field, with mutual funds, pension and endowment funds, trust companies, investment counselors, and family offices managing portfolios holding 60% or more of all U.S. equities. Concentration is high, with 26 firms managing over $100 billion of equities and the top ten managers averaging $360 billion . . .each! With less diversity among our peers and more size to say grace over come greater market impact and less investment mobility . . . and the eternal reversion to the mean in investment performance occurs with both greater certainty and greater rapidity. In these circumstances, there are many temptations for firms to try something new. We hear, without any supporting evidence, that managed separate accounts can offer higher returns and lower risks than mutual funds. (Certainly they offer higher costs!) We read about the magic attraction of hedge funds, without explanation of the often-hidden risks they assume, the diversity of their strategies, and the enormous diffusion of their returns.

Our goal is both to retain the loyalty of our clients through appropriate pricing, and to bring personalized interactions as close to personal meetings as possible. The shareholders truly care about the personal touch, a point driven home to me last summer when a group of nearly 50 shareholders who knew each other only through the Internet—the Morningstar Vanguard Diehards website, where they call themselves “Bogleheads”—came at their own expense to visit us at our Valley Forge headquarters. In a wonderful interaction of Internet technology and human values, the message was clear: Even in this world of electronic communications, human contact remains the desideratum. Information technology will be for the better only as it provides better communication—communication that educates as well as informs, that reminds us of our obligation to serve the needs of honest-to-God, down-to-earth human beings, who have entrusted their hard-earned assets to our care, each with their own hopes, fears, and investment goals. (5) Better Services for Shareholders? There can be no question but that technology has brought to mutual fund shareholders a level of service that is not only better, but better almost beyond imagination. What began with the revolution in telecommunications more than a decade ago—imagine the financial service industry without the 800 number!

We begin with a dividend yield that is only 1%, a fraction of the historical norm of 4%. That, to put it bluntly, is not a lot of gas in the market’s tank. But if we assume that corporate earnings growth will continue at its 7% annual rate of the past 40 years, stocks would enjoy a total investment return of 8% annually during the coming decade. 0.1 Investment Returns and Market Returns Two Contrasting 20-year Periods Investment Return 12.1% Market Return 7.5% 0.1 1961 - 1981 1981 - 2001 1961 1981 1981 2001 Investment Return 10.3% Market Return 15.2%

Indexes of Market Segments The problem with segment indexes is not that they have failed to perform effectively. Over the past decade, equity index funds have outpaced their comparable actively-managed peers in eight of the nine Morningstar style boxes, and when the bias of returns in favor the better- performing funds that have actually survived the decade is taken into account, the index advantage rises even further. Rather, the problem is that once we move away from large-cap and all-market indexing, portfolio turnover soars, with attendant turnover costs and tax-inefficiencies that erode the advantage that indexing usually carries. For example, more than 600 stocks have exited the Russell 2000-stock small cap index in each of the past two years, replaced by 600 new entrants. I think we owe it to ourselves to challenge the way these indexes are constructed, and to ask ourselves whether the rapid circulation of dollars (about 60% per year) among a floating menu of small-or mid-cap stocks represents a valid long-term investment strategy, even granting that the returns of the smallest-cap stocks (but not small- and mid-cap stocks as a group) seem to have garnered a long-term advantage over the returns of the market as a whole. Nonetheless, problems remain, including the fact that there is considerable diffusion among the returns of the various sub-indexes. The average rate of return over the past decade, for example, was 17.4% for the S&P 600 Small-Cap Index, but 15.

It requires not only interest and compassion and concern; it demands self-sacrifice, wisdom and tough-mindedness, and discipline. Every responsible person must care, and care deeply, about the institutions that touch his life.” So, if we ask those who work at Vanguard to treat their institution with care—the better to ensure that it meets the needs of the human beings we serve as clients—we must in turn treat our crew with care. The Human Organization and Service In our efforts to create a human organization, our compensation strategy, as I’ve noted, plays a key role.but,

Size, as such, is not necessarily bad. A giant market index fund, indeed, may have inherent advantages over a very small one. And the past record of a fund investing in large cap stocks on a long- term basis is likely relevant even if the fund has grown to a multi-billion asset base. But giant size limits the investment universe from which a manager must select the fund’s investments, as well as limiting (for better or worse) his ability to actively trade the fund’s holdings. As a result, funds that were once actively managed gradually come to resemble market index funds, without disclosing it, and without the benefit of low cost that indexing provides. The “closet index fund” is now a staple of the industry. While it looks like a duck, however, and walks like a duck, and quacks like a duck, it denies being a duck. But “duckness” can be measured. A correlation statistic known as R2 measures the portion of a fund’s return that can be explained by the return of the Standard & Poor’s 500 Index. The average equity fund has a correlation of 83, meaning essentially that 83% of the average fund’s return can be Index- explained. But 18 of the 30 largest blend funds investing in large cap stocks have correlations of 94 or above, very close to the 100 correlation of a S&P 500 Index Fund. If these funds are not closet index funds, they are something terribly close.

successful (past) performers. Such a strategy defies all reason except for this one: promotion of such funds brings in lots of new money, and lots of new fees to the adviser. But such promotions, finally, lead investors in precisely the wrong direction. Ignore them. So, be sure to disregard "lump sum" performance comparisons. But follow the next rule. Rule 4. Performance to Determine Consistency and Risk. Studying the nature of past returns enables you to determine consistency. Look at a fund's ranking among peer funds with similar policies and objectives (i.e., a large cap value fund with other large cap value funds, a small cap growth fund with other small cap growth funds, and so on). Morningstar makes this easy. It shows, in a simple chart, whether a fund was in the first, second, third, and fourth quartile of its group during each of the past 12 years. For a fund to earn a top performance rating means, in my mind, at least six to nine years in the top two quartiles and no more than one or two in the bottom quartile. This information-shown in this example of two real-world funds that reflect the standards I've set forth-is ignored by too many investors. CHART 19 The "good" fund is in the top half in 10 years, in the bottom quartile but once. The 'bad" fund is in the top half six times, (all in the early years-a significant factor) but in the bottom quartile four.

The Vanguard funds also voted against auditors at 21% of the firms, and against 64% of stock option plans. I believe that active voting policies by mutual funds will become more evident with each passing year. Once owners become used to acting like owners, once corporate citizens understand their rights and responsibilities in a democracy, once institutions begin to cooperate with their peers for the common good, we can at last begin the process of replacing Managers Capitalism with Owners Capitalism. Some Mind-Expanding Wisdom But there is more that needs to be done. And some important ideas about radical reform have been put forth by Robert A.G. Monks. Few individuals have been as deeply involved in corporate governance issues—and even fewer have played as constructive a leadership role—as Mr. Monks, founder of ISS as well as the corporate activist firms Lens, Inc., and Lens Governance Advisors. His fact-filled 564-page tome Corporate Governance (with Nell Minow) is a must-read for those who seek to understand what went wrong in corporate America and what needs to be done.Maker’s

abundance that shows that from a relative perspective quality stocks may today be considered expensive.’ The interesting point about that assertion is that it was published on 13th August 2012. A lot of superior returns have been had from those allegedly expensive stocks in the subsequent seven years. The argument might be encapsulated thus: stocks of the sort which our Fund owns have had a good run of outperformance as has the Fund but this is all about to end, or even has already ended, and so- called ‘value investing’ — buying stocks mainly based upon their supposed under valuation by the market — is making a comeback and funds which pursue that strategy are about to outperform us. Value investing has its flaws as a strategy. Markets are not perfect but they are not totally inefficient either and most of the stocks which have valuations which attract value investors have them for good reason — they are not good businesses. This means that the value investor who buys one of these companies which are indeed lowly rated but which rarely or never make an adequate return on capital is facing a headwind. The intrinsic value of the company does not grow (except for any new capital that its hapless investors allow it to retain or subscribe for in some form of share issue), or even erodes over time, whilst the value investor is waiting for the lowly valuation to be recognised and the share price to rise to reflect this.

According to an independent study, the average fund owner earned an annual rate of return of just 2.6% per year, nearly ten full percentage points short of the market's return, and seven percentage points short of the average fund—less return than a savings account would have produced, with no risk at all. Chart: The Stock Market, Funds, & Fund Owners Compounding: The Magic and the Tyranny Now let's compound those returns during the full period: $10,000 in the stock market itself would have produced a profit of $79,000. $10,000 in the average fund would have grown by $44,000—half as much. And the $10,000 invested by the average fund investor would have produced a profit of just $6,000. Just as the growth of $10,000 to $79,000 demonstrates the magic of compounding returns, so that reduction by a full $35,000—to a value of $44,000—demonstrates the tyranny of compounding costs. By the same token, the further $38,000 shortfall—amazing, isn't it!—incurred by the average fund investor demonstrates the woes of timing and selection, brought on as part of our focus on asset gathering at all costs. It is impossible to argue that we have given our shareowners a fair shake.Owners

Nonetheless, I can accept, if a bit grudgingly, the current fashion of “benchmarking”— comparing the return of a small-cap growth fund, for example, with the return of an index of small-cap growth stocks. As a short-term tool for ascertaining whether or not the manager is investing in accordance with his own proscriptions (and, assumedly, those of his clients), benchmarking seems reasonable enough. But over the long-run, it seems to me obvious that the fairest comparison of return is with the all-market index, not the style index. It is difficult to imagine that a client seeking a particular style—and a manager offering that style as representative of his or her particular area of expertise and comparative advantage—does not make that selection because it is expected to enhance long-term returns. “What gaineth the client,” one might say, “if he wineth the style derby, but loseth to the whole stock market.” For all of the scientific computerized data we see presented with grand precision— comparative returns, risk-adjusted returns, Alpha and Beta (with Omega not yet on our horizon), measured over short periods and long, and taken out to two decimal points and sometimes more—I think we in the profession have the duty, simply as a matter of fair and complete disclosure, to present both sets of comparisons—the style benchmark and the all-market benchmark—to our clients.

commensurately easy to attract serious long-tenn investors (today, an endangered species). The rewards for them should be far larger than the risks. The potential rewards, in fact, are huge. In a stock market which averages a 10% pre-tax return, an average fund, assuming a 2% expense ratio, should provide a pre-tax return of 8.0% and an after-tax return of 6.5%. A low-cost buy-and-hold fund with a 10% gross return and expenses of 0.2% should achieve a net return of 9.8% before taxes and 9.0% after taxes. (This is a conservative hypothesis, with an after-tax spread of 2.5% that is well below the shortfall of 3.3% that actually existed between active funds and the Standard & Poor's 500 Index during the past 15 years.) For the long-term investor, these numbers would be little short of dynamite. $100,000 invested at the outset would, after 25 years and after all taxes, have grown in the actively managed fund to $483,000. But the buy-and-hold fund would have almost doubled that amount to $862,000. I guess it's fair to conclude: "Yes, costs and taxes matter." The potential risk to investors is small. Essentially, it's the risk that the 30% of the entire investment universe represented by the 50 largest growth stocks today would underperform the remaining 70% of the market by more than 3.0% per year over the long-term. (At that figure, the choice between the two funds would be indifferent.)

realistic about what fund managers might accomplish. Even excluding the oppressive impact of sales loads, Graham’s view was that fund returns “were not very impressive . . . on the whole, the managerial ability of invested funds has been just about able to absorb the expense burden and the drag of uninvested cash.” Graham’s timeless lesson for the intelligent investor, as valid today as when he described it in his book, is clear: “the real money in investment will have to be made—as most of it has been made in the past—not out of buying and selling but of owning and holding securities, receiving interest and dividends and increases in value,” again exemplified in the distinction between the business market and the expectations market that I mentioned earlier. Owning and holding a diversified list of securities? Wouldn’t Graham recommend a fund that essentially buys the entire stock market and holds it forever, patiently receiving interest and dividends and increases in value? Doesn’t his admonition to “strictly adhere to standard, conservative, and even unimaginative forms of investment,” eerily echo the concept of market indexing? When he advises the defensive investor “to emphasize diversification more than individual selection,” hasn’t Benjamin Graham come within inches of describing the modern-day stock index fund?

D; intelligent selection of funds for future performance, D; investment behavior of shareholders, F.  Transaction technology: Ease and facility, A+, implicit encouragement to trade funds, A+; efficiency and expense savings, A+; flow-through of lowered costs to fund shareholders, F; facilitation of enhanced shareholder returns, F. My report card would rate the contribution of technology to information as A+; to knowledge, C; and to wisdom, D or perhaps even F. In all, good grades go to the technology, bad grades to the users. What does the technology revolution portend for tomorrow? More Websites, more bulletin boards. More information, more transactions, still more facilitation and speed, and more cost savings (though probably not flowed through to the benefit of fund shareholders). And, I must add, more risk. Most of the new financial instruments made possible by the computer power of technology have never been tested in the crucible of a bear market. Nor have most fund shareholders, who are now able to trade without restraint. And, given the Internet, they can do so without even the intercession that used to be represented—for better or worse—by the inability of funds to staff enough telephone lines. Anyone who is not cognizant of these risks is, in my view, making a serious mistake. But I am not an aging Luddite who is renouncing the future and calling for a return to the past. We can’t go home again.

But in the inevitably uncertain world of investing—and with the counterproductive interference of our emotions—I also think that betting the entire ranch on equities would be unwise. We are all fallible human beings, driven toward greed at market highs and toward fear at market lows. So, it is best to resist the temptation to turn emotion into investment action. A balanced approach has been validated over centuries, not, to be sure, because it provided the highest returns—it clearly didn’t. But it did provide solid long-term returns, achieved without excessive short-term risks, and that’s hardly an unacceptable outcome. With the stage—or stages!—thus set for future market returns, what does RTM suggest about equity investment selections? I come quickly to the obvious solution: the choice of a low-cost stock index fund for your equities, or at least as the core of your equity commitment. Such a fund should, given the power of mean reversion, provide the maximum participation that is realistically possible in the future returns of equities as a group. Surely it has proved its worth in the past. I would caution you, however, that despite the recent success of—and accompanying accolades for—index funds modeled on the Standard & Poor’s 500 Stock Index, they may not be the optimal choice.providing

Interestingly, for the full period both funds had similar annual returns of about 16%, and both ranked among the top one-third of their peers. But it is consistency of return, not aggregate return, that tells the important story to the intelligent investor. Careful analysis of past performance can also tell us a lot about risk. Risk is a crucial element in investing. The Morningstar risk rating gives you a rough guide to how much risk the fund typically assumes relative to its objective group and relative to all equity funds. This table shows, for example, that the average large cap value fund has carried but one half of the risk of its small cap growth fund counterpart.20

equally important, it also generates a powerful sense of loyalty among the crewmembers by emphasizing that they are the human beings who are the key to our success. Similarly, our Award for Excellence program, now going into its 16th year, has had the same focus. In this increasingly impersonal era, an era in which bureaucracy and technology threaten to obscure the contribution of the individual human being, the Award for Excellence is a tribute to individual effort. Numerous tokens accompany the award—a pin, a check, theater tickets, a contribution to a favorite charity. But the most treasured symbol is a plaque, on which remains the saying that I placed there 15 years ago: “I believe that even one person can make a difference.” One person—now multiplied 10,000 times over—still can, and still does, make a difference at Vanguard. The simple fact of the matter is that unstinting service has, by driving client loyalty, driven Vanguard’s growth. Included in our service goals is providing mutual funds that satisfy the client’s need for, and right to, the highest possible investment value, the highest possible profits, if you will. While we’ve done all in our power to win the loyalty of our crewmembers as well, a sort of virtuous circle has emerged: The constant expression of client satisfaction about performance and service to our crewmembers has reinforced their satisfaction that they are working for the right kind of company. (And not only for those on the front-line.

But I do hope we will soon return to the fundamental principle that mutual funds are best used as long-term investment. I’m enough of an idealist to be confident that the kind of casino capitalism that is in the air today will not be a permanent fixture in the mutual fund industry. For trading in fund shares not only places roadblocks in the way of the implementation of sound strategy, but also engenders additional costs to all of the shareholders in the fund. What is more, it is also a loser’s game for fund shareholders who elect to follow active trading strategies. Technology, for all its gee-whiz wonder, is both a bane and a blessing. In the fund industry, the idea of something for nothing is rife, and plain fantasy about future returns abounds. My asking earlier, “To what avail?” regarding the remarkable advances in the application of technology, was not intended to demean them.have

The Crucial Role of Speculative Return Will speculative return enhance or reduce that investment return? I suspect that it may change the return only modestly. For, given an increase in earnings and the market’s decline, the price-earnings ratio has now fallen to 20 times, not too far above its long-term norm of 16. If, ten years hence, investors continue to pay the same $20 for each $1 of earnings they pay today (a price-earnings ratio of 20), then the market return must—and will be—that same 8%. If the p/e ratio were to fall to its long-term average of 16, that would result in a negative speculative return of about minus 2% per year, bringing the 8% investment return down to 6%. If, on the other hand, the p/e ratio were to rise to 24 times, we’d have a positive speculative return of 2%, bringing the market return to 10%. Rational expectations, then, suggest a future return for stocks on the 6% to 10% range during the coming decade; that is, a return ranging from about the same as today’s bond yield to a nice equity premium of 4%. So, provided only that American business works through the present slowdown with its customary energy, resiliency, determination, and imagination, we’re unlikely to be facing the worst of times. What would it take to bring us to the best of times? For argument’s sake, let’s call that a return on stocks of 15% during the coming decade.

The recent market timing scandals in the fund industry, disgusting as they are, are fairly small change relative to the losses investors have incurred by the industry's excessive costs and by the industry's overwhelming focus on promotion and asset gathering. But the scandals have the entirely beneficial effect of shining the spotlight on the myriad conflicts that exist between the interests of mutual fund managers and mutual fund shareholders, and point the way toward reform, forcing this industry to focus not on the business of marketing, but on the profession of management—not salesmanship but stewardship—a change which I expect is at last on the way. Values and Idealism Let me close with a few words about values. I began these remarks by telling you of the idealism I held during my college days, and as I began my career. I want to close by telling you that even a long career in the competitive, dog-eat-dog, give-and-take of the mutual fund business hasn't dimmed my idealism one jot. Indeed, I believe that today there is even more idealism in my heart and soul than there was all those 54-plus years ago. At Vanguard, I did my best to create a company that would live up to those ideals. While the industry has yet to emulate them, I'm certain that moving in that direction is only a matter of time. The coming wave of reform in corporate America and in mutual fund America will help turn our nation’s capital development process away from speculation and toward enterprise.

success. I press on in the great cause of giving Vanguard shareholders—and all mutual fund investors—a fair shake, and I reflect on my own odyssey with the words Tennyson ascribed to Ulysees when that mythic warrior returned from his own odyssey and reflected on what might be next: So come, my friends ‘Tis not too late to seek a newer world. Push off, and sitting well in order smite The sounding furrows; for my purpose holds To sail beyond the sunset, ‘til I die. Tho’ much is taken, much abides; and tho’ We are not now that strength which in old days Moved earth and heaven, that which we are, We are; One equal temper of heroic hearts, Made weak by time and fate, but strong in will To strive, to seek, to find, and not to yield.

The powerful forces of efficient financial markets would likely repel any such challenge, and such a defeat for our hypothetical fund could be accomplished, over the long tenn, only against all odds. The surprising, if simple, fact is that broad diversification makes it just as difficult to achieve significant underperformance relative to the market as to achieve significant overperformance. In short, the risk-return equation appears highly favorable, thanks simply to the minimization of the fiscal drag of operating and tax costs. (That's the three dimensional view once again, as seen from this pair of eyes.) Perhaps a look at history might help to evaluate the risk that growth stocks, purchased at notably high valuations, might under perform the market over the long-run. Jeremy 1. Siegel, professor of finance at The Wharton School, has helped answer the question. He studied the performance of the famous Nifty 50 growth stocks of the halcyon Go-Go era of 1965-1972. In an article in The Journal of Portfolio Management [Summer 1995], Siegel shows that a frozen portfolio of these fifty high-priced stocks purchased at the start of 1971 in fact nicely outperformed the stock market over the next twenty-five years. Some of the fifty did well-Philip Morris was the champion, up 21%. With McDonald's (+18%), Coca-Cola, and Disney (each +16%) in close pursuit. Some did ill-MGlC Investment finished fiftieth, losing 4.3% per year, with Emery Air Freight (-0.

participation, not only in the giant cap stocks of the S&P 500, but also in the small-cap and mid-cap segments of the market. (While I see no compelling reason to include international equities in your program, I would note that they can be successfully indexed too.) The index fund is the ultimate response to the power of RTM in the selection of mutual funds. It avoids “the loser’s game” of selecting individual funds based on past performance that overpoweringly reverts to a mean that persistently falls short of the market return. Rare indeed is the serious study that suggests that it is possible to select significant winners in advance. Indeed, I accept the general notion of RTM among market segments such as growth stocks versus value stocks and U.S. stocks versus international stocks. But even if you believe that the clear lessons of history are pointing us in the wrong direction—always a risky bet—there would remain the equally risky bet of determining just which of the countervailing segments will in fact prove to be superior. If, for example, large cap and small cap stocks do not each revert to the market mean over the next 10 to 20 years, which of the two is the more likely to provide the superior return? Indeed, it is the extraordinarily broad diversification—the total, absolutely complete, diversity—of the total stock market index fund that commends it to investors. But only if that diversity comes with minimal cost.

It behooves you to know the R2 figures for the funds you own or are considering owning, and to decide whether the implicit limitations on extra return are too great to justify the costs involved. But I fear that in most closet index funds, you are unlikely to find either a perfect plan or a good plan. Rule 9: Don’t Own Too Many Funds—And Don’t Trade Them Let me ask your indulgence as I set forth one final rule: Limit the number of funds you own, and don’t trade them. To paraphrase the old adage, “too many funds spoil the perfect plan.” Why should this be so? First, the more funds you own, the greater the chance that a truly inspired fund selection will have its success spoiled by another fund that falls on its face. The problem has been called “diworsesification,” for it leads investors to build a portfolio of funds containing so many individual stocks that it becomes itself a closet index fund, again bereft of the index fund’s positive attributes of exceedingly low cost, minimal portfolio turnover, high tax efficiency, and clarity of investment objective. To me, that is too much good to relinquish in the search for the perfect. Recent studies have shown that the average mutual fund investor owns six mutual funds, and one of every four investors own ten funds or more.to

We are told about the magic of private equity and venture capital, but ignore the warnings from those who have managed them most successfully that their best days may be behind them. And we accept that all of these so-called alternative investments are a panacea that will somehow cure the ills of the more modest returns of stocks and bonds that seem so likely to lie before us. I’m not so sure. There are also great temptations to offer new services. We hear about the magic of technology that facilitates moment-by-moment account appraisal; about “screen-scraping” that combines accounts of multiple investment providers and facilitates moving money around from one provider to another; about Monte Carlo simulations that, by constructing complex multi-fund asset allocation strategies, are said to add predictability to forecasts. The whole thrust of these developments is that our value to investors can be enhanced by more sophisticated services, and that the greater the investor’s wealth, the more he or she will demand these services—but, I would add with some skepticism, only if these layers of complexity prove to be true services, and not disservices to investors. In my experiences, moving money around quickly is not the preferred route to wealth accumulation, and “don’t just do something, stand there” is not the worst of all advice.

Late in his life, in an interview published in 1976, Graham candidly acknowledged the inevitable failure of individual investment managers to outpace the market. He was asked, “Can the average manager obtain better results than the Standard & Poor’s Index over the years?” Graham’s blunt response: “No.” Then he explained: “In effect that would mean that the stock market experts as a whole could beat themselves—a logical contradiction.” Then he was asked whether investors should be content with earning the market’s return. Graham’s answer: “Yes.” Finally, he was asked about the objection made against the index fund—that different investors have different requirements. Again, Graham responded bluntly: “At bottom that is only a convenient cliché or alibi to justify the mediocre record of the past. All investors want good results from their investments, and are entitled to them to the extent that they are actually obtainable. I see no reason why they should be content with results inferior to those of an indexed fund or pay standard fees for such inferior results.” Graham was also well aware that the superior rewards he had reaped using his valuation principles would be difficult to achieve in the future.this

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.

Guide to Reform (with Allan Sykes)2, he sets forth a framework for fixing the system. His wisdom is worth considering. “Government involvement is clearly needed in corporate governance to guarantee the nation’s citizens the neglected rights of ownership of their stocks. What is needed is a clear and consistently enforced public policy that gives all owners’ representatives, the intermediary investment institutions and their fund managers, the clear fiduciary requirement to be active with respect to companies held in their portfolio accounts, and the confidence that they will not be placed at a competitive or reputational disadvantage with their competitors by complying. Above all else, it must be unmistakable that government intends, and is capable of enforcing, the trustee and fiduciary laws for the sole purpose and exclusive benefit of their beneficiaries’ interests—the great part of the funded pensions of most citizens—in an even-handed way. “1. In support of the fundamental principle that there should be no power without accountability, government should affirm that creating an effective shareholder presence in all companies is in the national interest and that it is the nation’s policy to aid effective shareholder involvement in the governance of publicly owned corporations. “2.

Moreover, even when the value investor gets it right and this happens, they then need to sell the stock which has achieved this and find another undervalued stock and start again. This activity obviously incurs dealing costs but value investing is not something which can be pursued with a ‘buy and hold’ strategy. In investment you ‘become what you eat’ insofar as over the long term the returns on any portfolio which has such an approach will tend to gravitate to the returns generated by the companies themselves, which are low for most value stocks. As Charlie Munger, Warren Buffett’s business partner, said: ‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return — even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.’ Our emphasis added. Mr Munger is not offering a theory or an opinion — what he is saying is a mathematical certainty. The only uncertainty concerns our ability to forecast returns far ahead, which is why we prefer to invest in relatively predictable businesses.

5% for the Russell 2000. In 2000- 2001 (through June 30), the S&P 400 Mid-Cap Index and the S&P 600 Small Cap Index both delivered +18.7%, while the Wilshire 4500 Index of all mid-and-small cap stocks declined by 20%. When we have to predict not only which segment will lead the way, but which index of that segment will lead the way, we’ve departed a long way from the basic wisdom of owning the entire market. $0 $10 $20 $30 $40 $50 $60 1989 1991 1993 1995 1997 1999 Ytd- 10/01 Billions Index Funds for Investment Index Funds for Speculation A Change is in the Air . . .Funds

Yes, I read all the arguments against independent counsel—there aren’t enough lawyers; they won’t be as experienced; they won’t be the best; they won’t have enough financial incentives; and believe it or not, in the face of the failings I’ve described, the industry “is not aware of any problems that have arisen as a result of current practices.” Although I have no doubt that the present proposal can be sharpened, these make-weight arguments must be disregarded, and the independent counsel proposal implemented. 2) Thou Shalt Elect An Independent Director As Thy Fund Chairman. The present fund chairman, by and large, is chairman or president of the fund’s management company.the

—now encompasses the round-the-clock ability to buy and sell stocks by the minute—and buy and sell funds by the daily close of business—electronically, simply by pressing a computer button and watching the trade, the clearing, and the settlement take place almost automatically, right before your eyes. What is more, without technology there is no way we could effectively administer shareholder accounts holding a variety of funds; IRA accounts with small monthly deposits; 401- K corporate savings plans with almost infinite fund choice (even self-directed brokerage accounts) and loan provisions; variable annuities; and withdrawal plans that automatically meet the minimum distribution requirements of the Internal Revenue Service—and do all of that almost flawlessly, if not yet at a Six Sigma level. At the same time, we have given investors almost unlimited choice of funds, plans, and programs, and the ability to change their portfolios at a moment’s notice. But all of these miracles of technology are not only for better; they are also for worse.asset

Let’s let narrow style benchmarking dictate neither our investment decision-making nor our standard for appraising long-term accomplishment. Variations on Long-Term, All-Market Indexing If the all-market index standard should—finally, must—be the long-term standard for equity accounts of all stripes, what use is served by the scores of index variations on this basic theme over the past decade-plus? I confess that, with the passage of time, I have become increasingly concerned about the utility of these variations, and I owe this audience the professional courtesy to tell you what bothers me and why it does so. First, confession being good for the soul, it was primarily because of my own drive and conviction that Vanguard became the pioneer in index funds. We formed the first S&P 500 Index fund in 1975, and then in 1987 pioneered the completion (“Extended Market”) index fund, tracking the small- and mid-cap stocks unrepresented in the S&P 500. The idea: To enable investors to make a commitment to the entire stock market, which I consider as the full fruition of the index fund concept.as

But there's even more at stake than improving the practices of governance and investing. We must also establish a higher set of principles. Our founding fathers believed in high moral standards, in a just society, and in the virtuous conduct of our affairs. Those beliefs shaped the very character of our nation. If character counts—and I have absolutely no doubt that character does count— the ethical failings of today's business and financial model; the manipulation of financial statements; the willingness of those of us in the field of investment management to accept practices that we know are wrong, the conformity that keeps us silent, the selfishness that lets our greed overwhelm our reason; all have eroded the character of capitalism. Yet character is what we'll need most in the coming new era I've described today; more than ever in the wake of the great bear market and the investor disenchantment it reflects; more than ever in these days when economies around the globe are struggling to find their bearings; more than ever in the strife-ridden world around us, where America's strength lies more than ever in her values, her ideals, her goodness. The motivations of those who seek the rewards earned by engaging in commerce and finance struck the imagination of no less a man than Adam Smith as "something grand and beautiful and noble, well worth the toil and anxiety."

business running soundly and to earn the largest possible profit for its owners. The fund chairman’s primary responsibility is, in a sense, precisely the same. . . but for a completely different constituency: To keep the fund running soundly and to earn the largest possible profit for its owners. The two responsibilities directly conflict: the more the manager charges in fees, the less remains for fund shareholders. Only by separating these two distinct responsibilities can we possibly begin the process of bringing management fees and profit margins under control. After all, when the fund chairman negotiates fees with the management company chairman, and they are the same person, we can hardly expect shareholders to come first. Warren Buffett put it perfectly: “Negotiating with oneself rarely produces a barroom brawl.” 3) Thou Shalt Get The Facts About Performance. Demand full, fair comparisons. Consider risks, peers, and appropriate market indexes. Look at cumulative returns over extended periods, and don’t forget after-tax returns. 4) Thou Shalt Get The Facts About Costs. For each fund you serve as a director, “follow the money.” Review the adviser’s profit-and-loss statement. How much did the fund pay? How much was spent on investment management? How much on marketing, and on administration? (Press hard on exactly how those expenditures on advertising—directly or indirectly, through 12b-1 plans—benefit the shareholder.)

Indexing wins because it is an exceptionally low cost strategy that is competing, finally, with all stocks as a group, by definition an equally-diversified universe. And the mutual fund portion of that universe—nearly one-quarter of it—is composed of thousands of different individual funds operating at high cost. In such circumstances, an equity index fund cost advantage conservatively estimated at 1.5% annually should provide 1.5% in added return over time. Yes, it is really just that simple. If the stock market’s return is 9% in the future, the typical fund should be expected to deliver 7.5% at best. (If you cannot accept my thesis about RTM in the relative returns of mutual funds, I believe your chances of selecting the future good performers will be highest if you choose from among those with low expense ratios and low portfolio transaction costs.) As shown in Exhibit XII, this difference in compounding causes $10,000 to grow to $61,000 at 7.5% over 25 years, but to $86,200 at 9%. Over 40 years, to $180,000 at 7.5%, but to $314,000 at 9%. It seems almost too easy a way to earn an extra nest-egg of almost $100,000, holding risk constant. But there it is. In short, excessive mutual fund operating costs carry a high penalty in shareholder capital accumulations over the long run. Cost matters.

be counterproductive. Even more counterproductive is the active trading of mutual funds. Typically, an investor today holds funds for but three years, an absurdly inadequate time frame for appraising the results of an investment program that should be inherently long-term by nature. What is worse is that the funds may ill-selected in the first instance—funds with inflated performance, funds investing in hot market sectors, funds advertised on television, funds that trade actively and relinquish much of their profit to taxes, funds with high costs that didn’t seem to matter when their past records looked so good. But the worst aspect of trading funds is that it allows the counterproductive emotions of investing to supersede the productive economics of investing. The dream of a perfect plan will never come true if mutual fund shares are traded as if they were stocks. The Perfect Plan or the Good Plan? I believe that my nine rules for selecting actively-managed funds should afford you considerable advantage in your quest for the perfect plan. Essentially, the idea is to buy right and hold tight. The problem is that only a fairly small number of funds will filter through my nine screens. There ought to be lots more. This industry needs to get its house in order. So demand that funds measure up to your standards.

Simplicity, Stewardship and Character So, I’ll continue to have faith in the majesty of simplicity, helping investors to make uncertain but necessary judgments to determine their allocation between stocks—with all their capital opportunity and risk—and bonds—with all of their income productivity and stability—and then doing everything in our power to diversify these investments and minimize the costs—management fees, operating costs, marketing expenses, turnover impact—promising only to give them their fair share of financial market returns, no more, no less. And if index funds are the best way to assure the realization of these goals, so be it. The ultimate objective of every firm represented in this room, I think, is to build a company that stands for something. As one who has been at that task for 28 years this coming September, I can tell you that it’s a tough, demanding never-ending task. My own goal has been to build a company that stands for stewardship. Let me be clear, however, that this goal is not without a self-serving aspect. For only to the extent we adequately serve the human beings who have trusted us to help manage their wealth will Vanguard itself survive and prosper. However each of you chooses to define your own firm, I hope that stewardship will be at least part of your character, because it will pay off for you.

All pension fund trustees, mutual funds and other fiduciaries must act solely in the long- term interests of their beneficiaries and for the exclusive purpose of providing them with benefits, in order to ensure the functioning of an appropriate board of directors. “3. To give full effect to the first two proposals institutional shareholders should be made accountable for exercising their votes in an informed and sensible manner. Votes are an asset which should be used to further beneficiaries’ interests on all occasions, and their voting should be virtually compulsory. “4. To complete and powerfully reinforce the other three proposals, such shareholders should have the exclusive right and obligation to nominate at least three non-executive directors in each company (held in their portfolios).” Wrapping Up The title of Mr. Monk’s monograph—Capitalism Without Owners Will Fail—is not an overstatement. Corporate America can only be an engine of the nation’s growth and prosperity and a major source of innovation and experiment if its managers are focused on creating long- term value for its owners. To the extent that managers sit unchecked in the driver’s seat, 2 Available at www.ragm.com/library/topics/ragm_sykesPolicyMakersGuide.html

I should note that while, over time, relative fund returns vary randomly from one period to the next, relative fund risks carry a healthy degree of consistency. So, especially in these volatile, speculative days, ignore risk at your peril. Given the recent emergence of fund portfolio managers as stars, I now turn to the next rule. Rule 5. Beware of Portfolio Manager "Stars." Alas, the fact is that this industry, as it painfully happens, has had precious few-if any-superstar managers who have had the staying power of Michael Jordan or Jack Nicklaus or, yes, Mark McGwire (though it's not clear that he'll repeat his feats over the next 15 years). And the precious few managers who may have fit into this category were never, as far as I know, identified in advance of their accomplishments. Who had ever heard of Peter Lynch or John Neff or Michael Price in 1972, before their splendid records had been achieved? To make matters worse, even our industry's temporary superstars seem to have a limited longevity with a given fund. The average portfolio manager in this business lasts but five years at the helm of a fund, and when the new manager takes over, the result is high portfolio turnover, costly and tax-inefficient. Fund stars, in truth, are more like comets: they brighten the firmament for a moment in time, only to burn out and vanish into the dark universe. Seek good managers if you will, but rely on workmanlike professionalism, experience, and steadfastness rather than stardom.

stocks moved in and out of the 500, creating portfolio turnover and potential tax-inefficiencies. So, in 1992 we created the all-in-one Total (U.S.) Stock Market Index Fund. That same year, when Standard & Poor’s/BARRA answered my public prayer and developed a growth index and a value index—each regularly adjusted to represent one-half of the weight of the 500—we started our Growth Index and Value Index Funds. I stated then—and reiterate now—my expectation that the long-term total returns were unlikely to differ significantly. The idea was to allow more aggressive long-term investors to hold the growth index fund for lower taxable income, higher tax-efficiency, and higher likely volatility. More conservative investors could hold the value index fund (for higher retirement income and lower volatility, at the cost of some tax-efficiency). Still earlier, in 1989, we converted a tiny actively-managed Vanguard small-cap fund into a passive Russell 2000 Index fund, creating the industry’s first small-cap index fund. And a few years ago, my successors at Vanguard added three more index funds—mid-cap (S&P 400), small- cap growth (half of the Standard & Poor’s 600), and a small-cap value fund (the other half). Over their histories, the segment funds formed before 1992 have done quite respectably—if largely unspectacularly. The newer funds, in even narrower market segments, have not been around long enough to fairly evaluate.

But in aggregate, on a pre-tax basis, the portfolio of Nifty 50 stocks earned an average return of 12.4%, compared to 11.7% for the overall stock market, a positive margin of 0.7%. This relative advantage grows on an after-tax basis, as the spread between the two returns increases to fully 2% (9.8% vs. 7.8%). This example of long-term returns on a "static portfolio," oriented to growth but bought at a high price, is surely reassuring. There is, Ecclesiastes tells us, nothing new under the sun. And that ancient maxim is in a sense true of my "new" idea. 1 may be one of a tiny handful of mutual fund historians who retain the memory of a similar fund formed in 1938, which provides further confIrmation of the buy-and-hold idea. Structured as a fIxed trust, Founders Mutual Fund originally picked an equal-weighted portfolio of 36 of the blue-chip stocks of the day, which it held, as it happens, until 1983, when the fund abandoned the strategy. And in fact, at the end of that 45 year period, the fimd held the same thirty-six stocks it had owned at the outset, including IBM, Procter & Gamble, duPont, Union PacifIc, and Eastman Kodak-not only durable (by defInition), but successful, enterprises. Prior to the change in its strategy (1 couldn't locate a record of its fIrst fIve years), the Fund earned an average annual return of 10.3% pre-tax, less than the return of 11.6% on the Standard & Poor's 500 Index, a gap predictably engendered in part by the Fund's operating costs of 0.5%.

In 1987, we developed a program under which virtually all crewmembers are trained to handle telephone inquiries from shareholders when call volumes soar. Mindful of European history, I named it “The Swiss Army.”) From my experience with our Vanguard crew, I’m shameless in my belief that innumerable numbers of America’s superb force of working men and women are, finally, idealists. They enjoy serving their fellow human beings; they revel in a sense of mission; they seek a career in an enterprise where integrity and candor are the watchwords; and when they interface with clients, and fellow crewmembers, and friends who know of our reputation, they feel proud of their life’s chosen work. No matter what the enterprise, please never underestimate the importance of pride as a driver of the commitment of the members of its crew. I’m an idealist too, and, shameless though it may be, I don’t apologize for it. It really seems to work. The Right Thing to Do As Vanguard’s founder, my leadership role has changed dramatically over the years.to

created and to figure out how to make it bow to our will, not us to its will. We must begin by obliterating the notion that funds should be treated as individual stocks—actively traded, sometimes in exotic forms, by managers who can create miracles. Abandoning the massive advertising of funds as though they were beer or toothpaste or perfume would be a step in the right direction. And we ought to give serious consideration to appropriate limitations on frequency of exchanges, and fee penalties for investors who redeem shares after short holding periods. All of these steps would be met with horror, not only by short-term investors who are using funds as stocks, but by the fund managers who seek additional assets without concern for their durability. But each of these steps would serve the interest of the long-term investors whom we are sworn to serve. I concluded my draft of these remarks before President Clinton used some familiar words from Benjamin Franklin to close his recent State of the Union Address. But, perhaps shamelessly, I’m going to present them to you anyway, for I want to end my remarks on an upbeat note.

Still assuming an investment return of 8%, we’d require a speculative return of 7%, which would require a final p/e ratio of nearly 40 times. Wow! I simply don’t believe that number is in the cards. In any event, the point is that when you consider most market forecasts, realize that they are largely guesses, not about earnings and dividends, but about market sentiment—in other words, about investor confidence. In that sense, simply predicting, in the abstract, the future level of the stock market is one giant confidence game. (I didn’t say con game, but I could have.) And who among us can do that with any claim to prescience? Market Returns in the Coming Decade? (April 2001 - April 2011) Negative- P/E 16x Positive- P/E 24x Dividend Yield 1% 1% Earnings Growth 7 7 Investment Return 8% 8% Speculative Return* -2 +2 Market Return 6% 10% Neutral- P/E 20x 1% 8% 8% Wow!ratio

allocation. To the contrary, the limited evidence we have suggests that quite the reverse is true. As investors, we have met the enemy, and he is us. It is not that technology hasn’t wrought miracles in creating new tools; it has done exactly that. But the fund industry has offered these tools to investors without providing the education required to assure the productive use, not the counterproductive abuse, of the system. And so redemptions of fund shares have soared. So have exchanges within fund families from one fund to another. Together they now run to nearly 40% of fund assets compared to 7% in 1961. Put another way, the holding period of the average fund investor has dropped from 14 years during the 1960s and 1970s to about 2½ years currently. Investors in mutual funds—as well as fund managers and direct investors in common stocks—seem enthralled by the new gadgetry and are ready, willing, and able to use it. But the result is that shareholders are increasingly using mutual funds for short-term speculation, sharply vitiating the value of the best medium even designed for long-term investing. I believe that trading mutual funds shares and trying to time the market are, finally, loser’s games. The marvelous new services that technology has enabled our investors to use are all too often being used counterproductively, and they will be poorer, not richer, as a result. (6) Better Financial Advice?

Growth vs. Value Similar issues can be raised about growth and value indexes. The major index provider—S&P/Barra—sorts stocks into the two classes primarily on the basis of relative price to book value. The stocks with higher P/B ratios are placed in the growth index, and those with lower ratios are placed in the value index, with each index accounting for one-half of the market’s capitalization. With the enormous outperformance of large-cap stocks during the bull market, the number of growth stocks plummeted from 230 to 106. The very success of Microsoft, Cisco, Intel, etc. miraculously transformed 124 of yesterday’s growth stocks into today’s value stocks, raising their number from 270 to 394 by early 2000. When the fall came, the newly growth-laden value index outpaced but 24% of all large-cap value funds during the year ended September 30, 2001, while the growth index, having lost so many growth stocks, outpaced fully 79% of all large-cap growth funds. This period became one of a very few departures from the superiority of these two indexes over their actively managed peers. Returns of the Extended Market 14.3% 16.7% 17.4% 15.5% 8% 10% 12% 14% 16% 18% Prudential Small-Cap Russell 2000 CRSP 6-10 S&P Small-cap -7.9% -19.5% 6.1% 3.8% 5.0% -30% -20% -10% 0% 10% 20% 30% Russell S&P CRSP Wilshire 4500 Mid Small 18.7% Avg. Ann.

The biggest flaw in value investing is that is does not seek to take advantage of a unique characteristic of equities. Equities are the only asset in which a portion of your return is automatically reinvested for you. The retained earnings (or free cash flow if you prefer that measure, as we do) after payment of the dividend are reinvested in the business. This does not happen with real estate — you receive rent not a further investment in buildings, or with bonds — you get paid interest but no more bonds. This retention of earnings which are reinvested in the business can be a powerful mechanism for compounding gains. Some 80% of the gains in the S&P 500 over the 20th century came not from changes in valuation but from the companies’ earnings and reinvestment of retained capital. If you were a great (and long-lived) value investor who bought the S&P 500 at its low in valuation terms, which was in 1917 when America entered world war one and it was on a P/E of 5.3x, and sold it at its high in valuation terms in 1999 when it was on a P/E of 34x, your annual return during that period would have been 11.6% with dividends reinvested, but only 2.3% p.a. came from the massive increase in P/E and 9.3% (80% of 11.6%) came from the companies’ earnings and reinvesting their retained earnings. The S&P example is for 500 average large companies.

remarkable concession, “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, but the situation has changed a great deal since then. In the old days, any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.” It is Benjamin Graham’s common sense, clear thinking, simplicity, and sense of financial history—along with his willingness to hold fast to the sound principles of long term investing— that constitute his lasting legacy. He sums up his advice: “Fortunately for the typical investor, it is by no means necessary for his success that he bring the time-honored qualities . . . of courage, knowledge, judgment and experience . . . to bear upon his program—provided he limits his ambition to his capacity and confines his activities within the safe and narrow path of standard, defensive investment. To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

Be careful too about "Morning-Stars." We exist today in a system in which funds want you to think that if their fund has 4 or 5 "Morning-stars" it is a success. But star systems don't always work. Indeed, the editors of Morningstar candidly acknowledge that their star ratings have little short term predictive value. Higher star ratings often-but not always--ean give clues to future success, but for sensible investors Morningstars are the beginning of fund analysis, not the end. Funds can get too big for their own britches. It is as simple as that. Rule 6. Beware of Asset Size. So, avoid large fund organizations that have no history of closing funds to new investors, and those that seem willing to let their funds grow to seemingly infmite size, beyond their power to differentiate their investment results from the crowd and irrespective of their investment goals. What is "too big" is complex. It relates to fund style, fund management philosophy, and fund portfolio strategy.limits

furthering their own interests at the expense of their owners, capitalism cannot flourish. Since no one—no one!—looks after assets as well as their owners, we must return them to their former preeminence. But even after needed system-wide reforms are put into place, the need to create an ownership ethic will remain. Changing the focus of management compensation from short-term stock prices to long-term corporate value will be a large plus. We might also consider a substantial tax, for taxable and tax-exempt investors alike, on capital gains realized in extremely short periods. We should consider paying a higher dividend to investors who hold their shares for longer periods—say, for more than three years. To move away from the focus on short-term fund performance, we should press for investment advisory contracts that, subject to safeguards, last for five years, with premiums for returns that exceed the market standard and penalties for returns that fall short. And the cause of owners capitalism would also be importantly furthered if we all took just a few moments to educate the man-on-the-street about the folly of short-term speculation and the wisdom of long-term investing. And we need to plant the seeds of cooperation among long-term investors. Index mutual funds, indexed pension accounts, and index-like investment pools operated under quantitative strategies would form the initial core.

If the longer-run past results of our market-segment index funds are at least respectable— and given the survivor bias that significantly overstates the achievements of actively-managed small-cap and mid-cap mutual funds, they are doubtless far better than that—what’s my concern? First, my instinctive feeling is that the use of segment funds is unlikely to add long-run value to the total market return. Second, I believe too many investors are using these funds to shift among market segments based on past performance, a formula apt to result in failure. Given the market trends that have favored growth stocks during the past five years, for example, the assets of our Large-Cap Growth Index Fund currently total $14 billion, compared to $3½ billion for its Value Index counterpart. (Surprise!) Third, segment funds carry far higher portfolio turnover: Small- Cap Growth and Small-Cap Value, each about 80% last year; Small-Cap (total), 42%; Large Value, 41%; Large Growth, 33%; and even Extended Market, 26%. In fairness, the extraordinary index fund management strategies of Vanguard’s skilled director of Quantitative Management, Gus Sauter, have resulted in virtually zero net cost for all of these purchases and sales, and each fund has tracked its appointed index with extraordinary precision.(6%)

I can't imagine that anyone in this room today would use those words to describe what capitalism has been about in the recent era. The sooner we can again apply those words to our business and financial leaders—and mean them—the better. And there's no one in this room who can't be part of this vital mission.

When I led Vanguard to offer the fund industry’s first small-cap index fund in 1989, and its first growth and value index funds in 1992, I found nothing in stock market history to suggest either such high turnover or such radical changes in the composition of style indexes. My idea was to offer particular funds that investors would buy and then hold for the long-term, either to diversify an actively-managed portfolio by adding market segments that were not included, or to do some intelligent portfolio allocation under special circumstances; i.e., a growth index fund for a young investor accumulating assets and seeking capital growth and tax-efficiency, a value index fund for the investor seeking higher dividend income and perhaps lower risk at retirement. Alas, to an important degree, those good intentions have been frustrated by investors who seem to use the growth and value index funds to make counterproductive investment decisions, just as they do even more spectacularly with actively-managed funds. At first our two index funds proved equally attractive. During 1992-96, investors placed approximately $700 million in both growth and in value. But as growth stocks soared, the temptation to jump on the bandwagon proved too strong to resist. During 1997 through the first quarter of 2000, investors poured $10.6 billion into the growth index fund, vs. $2 billion into value.