Bogle: Investors Are Now Driving Ethics

April 08, 2015 You’re saying it’s not about Vanguard, but this transcendent notion of real fiduciary responsibility that’s slowly coming into sharper focus. And we're seeing it in daily flows data?


Bogle: Absolutely. It's partly what people are reading, what people are writing, what academia is saying. But it's also that we now have a larger growing body of shareholders who have actually experienced that value.


I get letters from them every single day. And they are a bunch of happy campers. I've spent all morning answering correspondence from over the weekend and Friday. And every letter, better than the last one.


In one letter, a man just went out of his way to make sure I knew how much he and his two daughters appreciate what indexing has done. All three of them signed—the father and the two daughters—to make sure I knew the daughters appreciate it, too. They looked from their handwriting to be about 10 or 12.


And I wrote back to him, and said: “One reason you're happy is we've had such good markets on balance for all the time they've been here. And, you stayed through all the bumps. So, of course, you've done well. But you've done better because you've gotten your fair share of those returns.”


And that's all that indexing does. Prognosticate a little bit about indexing, won’t you?


Bogle: This industry is going to have a hard time selling its actively managed funds because they are fighting this cost battle. It's not just the expense ratios. That’s the least of it, as it happens.


Bill Sharpe produces this 100-basis-point total cost associated with a 6-basis-point total market index fund,. He compares it to a 112-basis-point average active equity fund and expense ratio.


The reality is that when you add up cash drag, mutual funds usually have 5-12 percent in cash. Then you add up portfolio turnover costs that they have to bear, and it's a high turnover business, averaging about 80 percent—and 80 percent is only the half of it, because it's based on securities you sell. And when you sell them, you've got to buy something else in return.


So, turnover is misstated—understated, if you will—in the official data, by 100 percent. So turnover is very, very high. And it carries heavy costs.


And then also there are all these other things—one is taxes. Index funds, outside of retirement plans, have about a 50-basis-point advantage over active funds. And then you've got marketing costs. Sales loads are not included in any of these data. And advisor fees are not included. And I use a very low 50-basis-points for that. Now we're up to 255 or 260 basis points, compared to Bill Sharpe’s number at 100.


And then you go one step further and you see that because of all these variations in performance, and investors move their money around, their behavior is counterproductive. And they get maybe another 150 basis points of loss because of the way they invest. That's the amount by which they lag the returns of the funds they own.


So you're up to a staggering number. It can get up to anywhere from 250 to 400 basis points, depending on which of those things you want to throw in. Cost is obviously a big factor. Anything else about indexing that’s worth teasing out?


Bogle: It also depends on the length of your holding period.


Indexing is not going to surpass actively managed funds next year and the next by around 300 basis points as it did last year. It's just not in the math. So I don't want people to get too excited about it. But realize that over a long period of time, if you can pick up an extra percentage point or 2 percentage points by indexing, that makes a difference.


What's going for the index fund is simply that it is not complicated. It is guaranteed to give you your fair share of the market return if you simply own the market in a cheap index fund.



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