John C. Bogle testified before the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises in the U.S. House of Representatives in Washington, DC on March 12, 2003. Following are some of Mr. Bogle's comments.
(NOTE: Exhibit numbers referenced in this document reflect their number assignments in the full testimony document and therefore may appear out of order here.)
Good morning, Chairman Baker. Thank you for inviting me to speak to the Subcommittee. I hope that my experience in the mutual fund industry will be helpful in considering the issues before you. My career in this business spans more than 53 years, most recently as founder and chief executive of The Vanguard Group of Investment Companies, and since 2000 as president of its Bogle Financial Markets Research Center. While I am no longer in a position to speak for Vanguard, my comments reflect the principles and values which I invested in Vanguard when it was created in 1974.
Since the day it began, Vanguard has operated under a mutual structure in which our management company is owned by the shareholders of the mutual funds we manage and operated on an at-cost basis in their behalf. Our unique form of organization, combined with our intense focus on minimizing investor costs, has enabled us to emerge as the lowest-cost provider of services in our field. The expenses of the average Vanguard fund today come to just 0.26% of assets, a reduction of nearly 65% since we began in 1974. (Exhibit I) The expense ratio of the average mutual fund, on the other hand, was 1.36%, fully 49% higher than in the late 1970s. How much does this difference matter? Our cost advantage of 1.10%, applied to our fund assets of $550 billion, now results in annual savings for our fund shareholders of some $6 billion.
Lower costs lead to higher returns. For what investors must earn, and do earn, is whatever returns the financial markets are generous enough to provide, minus the costs of financial intermediation. The returns earned by mutual funds as a group inevitably equal the market returns less the costs funds incur. This relationship is most obvious in money market funds. (Exhibit II) Over the past five years, 10 percent of money funds with the lowest costs earned a gross return of 4.80%, incurred costs of 0.37%, and provided a net yield of 4.43%. The highest-cost funds earned 4.67%, deducted 1.74%, and provided a net yield of 2.93%. Result: just by owning the lower-cost group, investors could have increased their income by more than 51%.
While less obvious, the same relationship prevails in equity mutual funds. Over the ten-years ended June 30, 2001, for example, the risk adjusted annual return for the low-cost quartile of equity funds was 13.8%, three full percentage points above the 10.8% return of the higher-cost quartile. (Exhibit III ) This relationship appears to be universal, prevailing in each one of the nine Morningstar 'style boxes'-large-cap growth funds, small-cap value funds etc.-and with remarkable consistency around the three percentage point level.
In the long run costs make the difference between investment success and failure. Over the past two decades, for example, the stock market provided an annual return of 13.1%, compared to the 10.0% return reported by the average equity fund. (Exhibit IV ) For the full period, $10,000 invested in the market itself grew by $105,000, while the same amount invested in the average equity fund grew by just $57,000, barely half as much. That 3.1 percentage point difference is largely a reflection of the costs that fund investors incur. So, yes, costs matter.