BRIEFING BOOK

Data Information Knowledge WISDOM

JOHN ‘JACK’ BOGLE

is the founder and retired CEO of the Vanguard Group, comprising of more than

100 mutual funds with current assets totaling about $950 billion

Location: Forbes, New York, New York

About Jack Bogle……………………………………………………….. 2 Debriefing Bogle..................................................................................

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Bogle in Forbes…………………………………………………………... “Good Riddance,” 11/17/08……………………....................... “Stocks in the Coming Decade,” 10/25/07................................ “Bogle Beats Down New Index Funds,” 05/10/07.....................

Forbes on Bogle

“Vanguard Steps Up to the Plate,” 01/28/08…………………… “Bogle’s Beefs,” 11/14/05......................................................... “Bogled Backwards,” 02/14/05..................................................

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The Bogle Interview…........................................................................ 26

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ABOUT JOHN ‘JACK’ BOGLE Intelligent Investing with Steve Forbes

John “Jack” Bogle is the founder and retired CEO of the Vanguard Group, comprising of more than 100 mutual funds with current assets totaling about $950 billion.

He is an author several books, his current book, Enough: The Measures of Money, Business and Life, will be released by John Wiley & Sons in November 2008

He runs his own financial blog and runs a popular “Ask Jack” section. Bogle has legions of fans that try to emulate his investment style and cheekily call themselves “Bogleheads.”

Bogle essentially invented the index fund. As an undergraduate student at Princeton, he declared a major in economics, which culminated in a senior thesis in which he laid the groundwork for his later career as a champion of index funds available to individual investors.

Bogle began his career by working for financial advisor Wellington Management from 1951 to 1974. A year after leaving Wellington, he founded Vanguard.

Bogle, who was named one of Time's 100 most powerful and influential people in 2004, serves on the board of trustees at his high school, Blair Academy, and has served on the advisory board for the Millstein Center for Corporate Governance and Performance at the Yale School of Management.

Bogle and his wife, Eve, live in Bryn Mawr, Pennsylvania. They have six children and a dozen grandchildren.

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DEBREIFING BOGLE Intelligent Investing with Steve Forbes

By David Serchuk 12.8.08 Forbes: What is one misplaced assumption in business today? The idea that we have a free enterprise capitalistic system, when we privatized the rewards of investing, but socialized the risks. It is not free enterprise, it is fettered enterprise. What was the best financial lesson you've ever learned? I guess the best financial lesson I've ever learned was about investing, as distinct from finance. I was a runner in a brokerage firm in 1947, 1951 and an old runner with me said, Bogle, the only thing you need to know is that nobody knows nothing. Meaning our markets are highly efficient, (but) there are surprises every day. They are not perfectly efficient. And everybody may know something, but no individual is smarter than the market. In my first book I said don’t think you know more than the market, nobody does. Another lesson worth talking about is in my new book "Enough." You should decide when you put your money to work whether you are an investor or a speculator. To me speculation is betting on the price of the stock, or the market. And it could go up or down, and you are trading around that. Investing is putting your money into a corporation with the knowledge that over generations the money put in over time will generate a substantial return of the capital. Compare this to when I was told nobody knows nothing. We had a small corporate failure rate in the '50s. Today it is larger than it's ever been, partly because of the recent crisis, partly because of globalization, and sweeping advances in tech. Somebody can have a brilliant idea Tuesday, and they're out of business Wednesday. So instead of picking a stock or two, you own the entire U.S. stock market. And it's called the Total Stock Market Fund. I started the first index fund in 1975, so it gives me a strong bias. The index has performed strongly since then compared to investors as a group. The long time return on stocks has been 9.5%. This 9.5% return (is made up of) a 4.5% dividend yield and 5% earnings growth. In certain decades you can have a 7% a year speculative return. But speculative returns in the long run are zero. It's all down to investment. To me its simple, not

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complicated. We know what today's dividend yield is. We know what the entry level dividend yield is. It's been a 3.5% dead weight loss to future returns in the first decade of this century. Now it's 3%, the yield is going up, the market's going down. Now we're back in the realm of reason instead of foolishness in terms of dividend yield. This is the deep, dark secret of American capitalism: corporate earnings grow at the rate of our gross domestic product. It seems all too likely, in normal terms, that future returns are quite forcastable. We know what today's dividend yield is. It's been around 6% of GDP; it's been higher than 8% in recent years. I look at investment (system) as being deeply troubled. Our system costs too much cost and does not provide enough value. The more you pay the less you get net. If the market gives 8% return, and it costs 2.5%, you get 5.5%. That's what is called the relentless rules of humble arithmetic. There is too much cost in the system and not enough value. There is too much speculation and not enough investment. The turnover in the market is two and a half times what it was in 1929. Speculation is in the driver's seat and investment has been put aside. There is too much complexity and not enough simplicity. Owning the total stock market is tax efficient and cost efficient. Your profits are not going to marketers and entrepreneurs. Yet we create new products in mutual funds that are focused on salesmanship rather than stewardship. People create new products—I hope you're sitting down—to make themselves wealthier, not their clients. The financial system is deeply troubled. To make earnings grow we've gotten into all this leverage. And ignored the extraordinary credit risk developing. The financial sector deserves a good, sound spanking. We ought to work towards a better financial system. I hope under President Osama, that the group he assembles under Paul Volcker and Larry Summers will take a look and stand back and have a little introspection about where our financial system went off the rails. We need more regulation, without any question. But I do not believe that the Federal government will run a better system than private enterprise will. Even though private enterprise is not looking so good today. Who is the greatest financial mind working today? David Swensen from Yale University and Warren Buffett. Throw Paul Volcker in too. Why Swensen?

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First, he has done an extraordinary job for 15 years, and done it in a way that did not enrich himself. He is modest in his aspirations. That's one of the big themes of my book: he makes a contribution to his community. He also knows investing and has acumen. He is enriching not only Yale University but American education with what he's done. And he's an extremely gifted writer, telling investors what can be done to capture their share of market returns. What is your bold prediction for the future? As for the stock market nobody can predict it. Maybe there will be some dividend cuts. I don’t think they will be serious. My bet, dividends will hold their own ground. We are now dealing with a dividend yield … of 3% at the starting point. From these depressed levels, earnings can maybe grow at 7% per year. Which will give you a 10% investment return. On other hand when you look at long term Treasuries yielding 4%, it starts to look attractive. So stocks look pretty good today. I wouldn’t do market timing. The rule I have for most people, not Steve, is that bond position should have something to do with your age. If you are in your 79th year, as I am, you should have 79% of your investments in bonds, and that's what I have. As you get older, you have more capital at stake, and more interest in the income. Corporate bonds produce more income than governments bonds. All those things say more safety, more bonds for the future. Stocks have done better in most 10 year periods than bonds. The number is one out of six decades bonds do better than stocks. The other thing is the economy, and I happen to believe and we are seeing shreds of evidence that this is going to be the most serious recession since the 1930s. I don’t believe it will turn into a depression. The stock market is down 50%, the economy is going into a pretty good sized tank. I think the bottom of the recession will (take place) over 18-24 months. That's the rough estimate. I don’t think it'd gonna be over tomorrow. Equally important, I don’t think it's gonna last forever. Is it over-discounted? I think the market's got it just about right. There ought to be some light at the end of the tunnel. But only looking ahead a decade. The short term fluctuations mean nothing. How do you think the mutual fund industry will deal with the retirement of the Baby Boomers? The mutual fund industry just got a lot of egg on its face. Very few enduring funds, come through this thing (looking good). In 2008 just about every major fund manager, Long Leaf, Dodge and Cox, even Vanguard, had funds that have done quite badly, worse than the market. People have been complaining about the index fund since I started it. But this year the S&P 500 outperformed 68% of all U.S. comparable large cap funds. If you look at the world, the S&P 500,

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outperformed almost 80% of all fund managers. It's been a banner year for indexing, giving the lie that fund managers would predict this market. They didn't. You created the first indexed mutual fund more than 30 years ago and have since refined the idea. What do you think would comprise the ultimate indexed portfolio of both stocks and bonds? For me, a U.S. believer still, I would say the U.S. total stock market index, and the U.S. Bond Market index. The bond portion should have to do with your age. Where if you're 65, it should be 65%. That should be the core portfolio. And if that's too boring, do it for 85-90% of your assets, and have some fun with the other 10%. And then look at your fun account and see how much it's lost to the index by every couple of years.

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BOGLE IN FORBES Intelligent Investing with Steve Forbes

On My Mind Good Riddance John C. Bogle 11.17.08, 12:00 AM ET

The silver lining around Wall Street's collapse.

The failure of our financial system has brought what looks like a significant recession upon the land, with hardship resonating throughout the economy. The citizens of New York City were the first to feel the blow. By September 2008, before the markets started their most precipitous dive, employment in financial and insurance jobs in New York had already dropped 5% to 335,000, from 354,000 in August 2007. Nationwide, the financial sector announced 153,000 job cuts in 2007. When the 2008 cuts are tallied, they are sure to reach 200,000 or more. And 2009 isn't looking good, either.

It will be hard for many citizens, far less well-to-do than hedge fund managers and stock analysts, to get by. In 2006 the wealthiest 20% of wage earners in Manhattan made $350,000 on average, nearly 40 times the $8,800 income earned by the poorest 20%.

But there is a silver lining around the loss of jobs among the large portion of that 20% who work in financial services. Last year a substantial sum, $620 billion by my rough calculation, poured into a system that supports the money shufflers and middlemen, whom I call the "croupiers," of the financial services industry. That's a lot to pay for financial intermediation. Where did I come up with $620 billion? I used data from a trade group, the Securities Industry & Financial Markets Association, from Lipper, from an outfit called Empirical Research Associates and from my own estimates of fees charged for legal and accounting services ($15 billion), financial advisers ($10 billion) and bank trust departments ($5 billion).

And don't forget that these costs recur year after year. Even as I expect these numbers will drop until the present crisis passes, aggregate intermediation costs could easily total $4 trillion over the next decade. Now think about these cumulative costs relative to the $9.5 trillion value of the U.S. stock market and the $30 trillion value of our bond market.

So what does it mean when a portion of these billions suddenly vanishes? We know from history that the effect on New York City can be devastating. Following the 1973--74 stock market crash the city suspended principal repayments on its notes (while gamely insisting that this was not a default). Bondholders were eventually made whole, but the blot remained on this big borrower's credit report.

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As the layoffs descend on New York, with even mighty Goldman Sachs announcing in October that it would ax 3,000 jobs, the city must retool. This presents a golden opportunity. We have quite enough lionizing of the notion of "success" as popularly defined, by a certain kind of material wealth, fame and power, the kind of success, in other words, that we have come to associate with Wall Street's wizards. Our obsession with these flawed markers of success has, in turn, led to far too much young talent flooding into a field that inevitably subtracts value from society.

I am not the only one to make this observation. In Berkshire Hathaway's 2005 annual report Warren Buffett offered the parable of the fictional Gotrocks family. Sole owners of corporate America, this huge clan sits back and collects the generous rewards of investing. Until fast-talking helpers arrive and persuade some family members to pay the helpers to try to earn more at the expense of other family members. But in total the family ends up with less. Why? Because the Gotrocks are now paying the helpers, thus diminishing the total return earned by all the businesses in their portfolio. Worse, the Gotrocks are now forced to pay taxes on the capital gains incurred as the helpers swap stocks back and forth. After several go-rounds with different helpers, the Gotrocks finally listen to an old, wise uncle who advises them to fire all the helpers and simply reap 100% of their investment gains themselves.

I do not wish suffering on the people of New York City. But maybe we should be grateful for any shrinkage in a system that has too many people engaged in shuffling the assets owned by the rest of us.

John C. Bogle is the founder and former chief executive of the Vanguard Mutual Fund Group and author of Enough: True Measures of Money, Business, and Life (Wiley, $25).

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Markets Stocks In The Coming Decade John C. Bogle 10.25.07, 6:00 PM ET

Common sense tells us we're facing an era of subdued returns in the stock market. There are two kinds of return. "Investment return" measures the capital gains and dividends from companies experiencing earnings growth. "Speculative return" represents the emotions of investors that can add to or subtract from investment returns in the short term.

In 1999, if we'd had the Keynesian wisdom to consider the sources of past stock returns, we would have likely recognized a bubble that was about to burst. First, the dividend yield--a known quantity--had fallen to an all-time low of 1.2%. This eliminated the dividend's power to drive future investment returns and left the heavy lifting to earnings growth.

I picked 8% as a reasonable expectation for earnings growth in the coming decade. Given that figure, investment return for the first decade of the 21st century would have come to about 9%.

What about speculative return? Over the previous two decades, the market's price-to-earnings ratio had soared from 7 to 30.5, producing a 7.5% annual contribution to investment return. By 1999, the P/E level was more than double the century-long average of 14.5 times.

Even if one naively believed that "this time is different," and that such a stratospheric ratio would remain at that level, the future speculative return would be zero. But my guess was that the P/E ratio might drop to the neighborhood of 20 times--still above the norm--providing a negative speculative return of about 4 percent per year. Result: An expected average return on stocks in the 1999-2009 decade of about 5% annually.

Please be clear that I was not forecasting 10 individual years each with returns of 5 percent; the stock market just doesn't behave that way. More likely, I said, was a 40% or 50% drop over a few years, followed by a return to a more normal figure, say around 9% annually.

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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 wind: "So let me be clear. You can put 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." And that's exactly what happened. The stock market promptly tumbled by precisely 50% to its low in October 2002, when it began its 80% subsequent recovery.

So far, my early guesses about the future look pretty good. Seven-plus years into the 1999-2009 decade, my total return forecast still looks realistic. Earnings have grown at 8.7% annually--even better than my 8% forecast--a rate that, combined with that 1.2% initial dividend yield, has provided a very solid investment return of 10%.

P/E ratios, however, have fallen to 17 times, producing a speculative return of -7.1% annually. Combining the two, we get a total return of 2.9%, not far from the S&P 500's actual return of 2.2% for the period.

Now let's set some reasonable expectations for what stocks might do in the next 10 years. The dividend yield has nearly doubled to 2%. Using a more modest 6% earnings growth assumption--hardly guaranteed!--the future investment return on stocks could be around 8%. Will speculative return add to or detract from that figure? With P/Es now around 17 times (based on "normalized" operating earnings, which is a bit of a stretch), I'm dubious that we will get much of a boost there. I actually expect a little harm in the form of a slightly lower P/E a decade hence, a negative speculative return that might shave a point off the investment return.

So reasonable expectations--seasoned, as always, with optimism--suggest a future return on stocks averaging perhaps 7% per year. But please don't agree with me uncritically. Make your own forecast: Just add your own earnings growth estimate to today's 2 percent dividend yield, and take a guess at speculative

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return. Then combine them. But never forget it's unwise in the extreme to forecast stock returns without evaluating the broad forces that will shape them.

Let me reiterate the clear message: The stock market's long-term returns are created by the fundamental investment returns achieved by American business. If you don't believe me, listen to these words from Ben Graham's most eminent protégé, Warren Buffett. His firm, Berkshire Hathaway, is publicly held, and he regularly hammers home the message that he prefers its shares to trade at or around its intrinsic value--neither materially higher nor lower.

He explains: "Intrinsic value is the discounted value of the cash that can be taken out of the business during its remaining life . . . When the stock temporarily overperforms or underperforms the business, a limited number of shareholders--either sellers or buyers--receive outsized 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."

Never forget this compelling refrain from one who knows what's important in investing. It's all about the intrinsic economics of business.

John C. Bogle is the founder of Vanguard. His latest book is The Little Book of Common Sense Investing (Wiley, 2007).

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Mutual Funds Bogle Beats Down New Index Funds John C. Bogle 05.10.07, 11:00 AM ET

Since the inception of the first index mutual fund in 1975, indexing--investing in passively managed, broadly diversified, low-cost, stock and bond index funds--has proved to be both a remarkable artistic success and a remarkable commercial success.

In terms of artistic success, index funds have been able to provide returns to investors that have vastly surpassed the returns achieved by investing in actively managed mutual funds.

Given that success, the commercial success of indexing is hardly surprising. Today, most indexed assets are concentrated in classic index funds representing the broad U.S. stock market (the S&P 500 or the Dow Jones Wilshire 5000), the broad international stock market (the Morgan Stanley EAFE [Europe, Australia, and Far East] Index), and the broad U.S. bond market.

Assets of these traditional stock index funds have grown from $16 million in 1976 to $445 million in 1986, to $68 billion in 1996, to $369 billion in 2006--7% of the assets of all equity mutual funds. Assets of bond index funds have also soared--from $132 million in 1986, to $6 billion in 1996, to $62 billion in 2006--7% of the assets of all taxable bond funds.

Success Breeds Competition

Indexing has become a competitive field. The largest managers of the classic index funds are engaged in a fiercely competitive price war, cutting their expense ratios to draw the assets of investors who are smart enough to realize the price is the difference.

This trend is great for index fund investors. But it slashes profits to index fund managers and discourages entrepreneurs who start new fund ventures in the hopes of enriching themselves by building fund empires.

So how can promoters take advantage of the proven attributes that underlie the success of the traditional index fund?

Why, create new indexes! Then claim that they will consistently outpace the broad market indexes that up until now have pretty much defined how we think of indexing. And then charge a higher fee for that higher potential reward, whether or not it is ever actually delivered.

Traditional indexes are cap-weighted. That is, the weight of each stock (or bond) in the index portfolio is determined by its market capitalization. The total U.S.

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stock market, with a value of $15 trillion, represents the collective investment of all stockholders of U.S. equities. So it follows that, together, all investors as a group earn precisely the market's return.

If the market rises by 10%, all investors as a group earn 10% (before costs). So the miracle, as it were, of the index fund is simple arithmetic. By minimizing all those costs of investing, it guarantees that its participants will earn higher net returns than all the other participants in stock ownership as a group. This is the only approach to equity investing that can guarantee such an outcome.

The Active Approach

The only way to beat the market portfolio is to depart from the market portfolio. And this is what active managers strive to do, individually. But collectively, they can't succeed, for their trading merely shifts ownership from one holder to another. All that swapping of stock certificates back and forth, however it may work out for a given buyer or seller, enriches only our financial intermediaries.

The active money manager, in effect, puts forth this argument. "I'm smarter than the others in the market. I can discover undervalued stocks, and when the market discovers them and they rise in price I'll sell them. Then I'll discover other undervalued stocks and repeat the process all over again. I know that the stock market is highly efficient, but through my intelligence, my expert analysts, my computer programs and my trading strategies, I can spot temporary inefficiencies and capture them, over and over again."

Some fund managers have actually succeeded in this task. But they are precious few in number--over the past 36 years, just three funds out of 355 have consistently distinguished themselves. Nonetheless, hope springs eternal among money managers, and they strive for excellence. Of course, they believe in themselves (this field has few shrinking violets!), but they also have a vested financial interest in persuading investors that if they have done well in the past they will continue to do so in the future. And if they haven't done well in the past, well, better days are always ahead.

Indexing Gets Active

In recent years, something new has been added to the mix. There are now financial entrepreneurs who believe--I'm sure, sincerely (if with a heavy dollop of self-interest)--that they can create indexes that will beat the market. Interesting!

They have developed new methods of weighting portfolio holdings that they vow will outperform the traditional market-cap-weighted portfolio that represents the holdings of investors as a group. This new breed of indexers--not, in fact, indexers, but active strategists--focus on weighting portfolios by so-called fundamental factors.

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Rather than weighting the individual stock holdings by market cap, they use a combination of factors, such as corporate revenues, cash flows, profits or dividends. (For example, the portfolio may be weighted by the dollar amount of dividends distributed by each corporation, rather than the dollar amount of its market capitalization.) These strategists 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 actually 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. (This is called data mining, 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.)

The members of this new breed are not shy about their prescience. They claim variously, if a tad grandiosely, that they represent a "new wave" in indexing, a "revolution" that will offer investors better returns and lower volatility, and a "new paradigm." Indeed, they describe themselves as the new Copernicans, after the man who concluded that the center of the solar system was not the earth but the sun.

They compare the traditional market-cap-weighted indexers with ancient astronomers who attempted to perpetuate the Ptolemaic view of an Earth-centered universe. And they assure the world that we're at the brink of a "huge paradigm shift" in indexing.

They come armed with vast statistical studies that prove how well their methodologies have worked in the past (or at least since 1962, when their back-tested studies began). But think for a moment about one of the most fundamental rules of mutual fund investing: The past is not prologue. These new paradigmists casually ignore that truism.

For example: "Dividend indexes outperform capitalized-weighted indexes." (Not "have outperformed in the past.") "The fundamental index adds more than twice as much incremental return." (Not "has added in the past.")

Investors (and managers too) love to believe that the past is prologue. It would make life so easy. But it is no accident that these new index funds are being introduced only after their strategies have seen their best days. Following the stock market's bubble burst in 2000, value stocks outpaced growth stocks (the market-cap index holds both) over the subsequent five years. For dividend-paying stocks, the pattern is about the same.

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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% per year. How much of that edge would have been confiscated by their expense ratios? (The lowest is 0.28%; the average is about 0.50%; the highest that I've seen is 1.89%.)

How much would have been confiscated by their extra portfolio turnover costs compared with the classic index funds? How much would have been confiscated by extra taxes paid by shareholders when that turnover resulted 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 would be significantly eroded, if not totally erased, by those costs.

But the central issue remains: How can one claim that the past will be prologue without a scintilla of apparent doubt?

The new paradigmists have never explained why these fundamental factors have been systematically underpriced by the market in the past. And, if they have been underpriced, why investors, hungry to capitalize on that apparent past inefficiency, won't 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?

When active managers of 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 records, consider the managers' strategies and invest or not.

These new index managers are in fact active managers. But they claim not only prescience but a prescience that gives them confidence that certain sectors of the market (such as dividend-paying stocks) will remain undervalued as far ahead as the eye can see.

I recommend skepticism.

I have always been impressed by the inexorable tendency for reversion to the mean in security returns. For example, mutual funds with a value mandate have generally outperformed those with a growth mandate since the late 1960s. But since 1977--indeed since 1937--there has been little to choose between the two. In fact, from 1937 through 1967, growth mutual funds rather consistently trumped value mutual funds.

Never think you know more than the market. Nobody does.

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We never know when that reversion to the mean will come to the various sectors of the stock market. But we do know that such changes in style leadership have invariably occurred in the past. With so much of the stock market's volatility based on expectations (emotions) rather than business (economics), what else could we expect?

Before we too easily accept that fundamental indexing--relying on style tilts toward dividends, value or smallness--is the new paradigm, we need a longer sense of history. We also need to call on our own common sense that warns us that hindsight plays tricks on our minds.

There have been many new paradigms over the years. None has persisted.

--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 and went as well.

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.

Traditional 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% 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.

I urge investors 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.

Don't forget the prophetic warning of Carl von Clausewitz, military theorist and Prussian general of the early 19th century: "The greatest enemy of a good plan is the dream of a perfect plan." Put your dreaming away, pull out your common sense and stick to the good plan represented by the classic index fund.

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John C. Bogle was the long-serving chairman and chief executive of the Vanguard Group, which he founded in 1974. Since 1999, he has served as president of the Bogle Financial Markets Research Center.

Courtesy of AAII. This article is excerpted from John Bogle's new book, The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns ($19.95), published by John Wiley & Sons, 2007. It is reprinted with permission

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FORBES ON BOGLE Intelligent Investing with Steve Forbes

2008 Fund Guide Vanguard Steps Up To The Plate Michael Maiello 01.28.08, 12:00 AM ET

The master of indexing got a late start introducing ETFs. For investors, it was worth the wait.

John Bogle, founder of the Vanguard Group and one of the 20th century's great innovators in finance, made a colossal mistake 17 years ago. He sent Nathan Most packing.

Most, then a 77-year-old product developer for the American Stock Exchange, had an innovative idea of his own: the exchange-traded index fund. Investors would have shares in a fixed portfolio, just like the one held by the Vanguard S&P 500 fund, but would trade these shares as if they were Microsoft stock. They could buy and sell the index fund all day long, they could sell the fund short, and they could borrow against the position. Shares of the tradable index fund would be created or extinguished in response to market demand.

Bogle, who ran Vanguard until 1996, was not interested. Trade index funds? Why, that would defeat the very purpose of indexing, which is to get savers to buy and hold passively for a long time.

Most went to State Street, and in January 1993 the Boston firm debuted its Spider Trust, an exchange-traded fund that tracks the S&P 500. Barclays Global Investors soon followed with its iShares. Most's brainstorm has turned into a $576 billion industry. Novel ETFs are being created every day (Click here for story).

Most, who retired from the Amex at 82, died four years ago. Bogle, now 78, is unrepentant. He still thinks tradable funds encourage investors' worst habits, and he is especially scornful of narrow ETFs that track just one sector of the market.

But Bogle's successor as chief executive of Vanguard, John Brennan, is not so dogmatic. Vanguard belatedly got into the ETF business in 2001 and now has $43 billion in these funds. It's a small but fast-growing part of Vanguard's $1.3 trillion in assets.

Hot-money types use ETFs to hedge. So now Daniel Wiener of Brooklyn, head of Adviser Investment Management ($1.3 billion under management), who also writes a newsletter about Vanguard, is pushing a new strategy he calls "Vanguard ETF Momentum" that would make a day trader blush. So much for buy and hold.

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Vanguard is way behind Barclays, which has $326 billion amassed in 149 ETFs. But it could narrow the gap by appealing to cheapskate investors, since efficiency is one part of the Bogle legacy that remains very much alive at headquarters in Valley Forge, Pa. Of the 25 cheapest ETFs, 19 are from Vanguard. The very cheapest is Vanguard Total Stock Market Index, charging just 7 cents a year to handle $100 of assets.

The catalysts for Vanguard's turnabout were the Russian and Asian financial crises and the Long Term Capital Management collapse of 1998. George (Gus) Sauter, then manager of the Vanguard 500, saw a rash of redemptions, just as he had during the 1987 crash. "There was a scar," says Sauter, now chief investment officer. With a standard mutual fund, redemptions force the fund manager to raise cash by selling shares of Microsoft and ExxonMobil in its portfolio. With an ETF that doesn't happen: A panicky shareholder merely sells ETF shares to another investor. Unlike a closed-end fund, however, an ETF never suffers a deep discount to its net asset value. When sellers push down the price of the ETF, arbitragers can step in to buy the discounted shares, then hand those in for a redemption in kind (shares of Microsoft and Exxon and so on).

Brennan's rationale for selling ETFs to investors is like that of a dad with teenagers: They're going to drink anyway, so it's safer if they drink at home. "It's paternalism," he says with a sigh. "But I guess it's better that they buy a health care ETF than health care stocks."

In November 1998 Sauter proposed setting up ETFs that would track existing Vanguard index funds. The Vanguard board approved the concept the next month. The Securities & Exchange Commission took a year and a half to render the necessary approvals since an ETF had never had a mutual fund link before.

Sauter's plan hit an immediate snag when Standard & Poor's sued Vanguard to stop the release of an ETF based on the Vanguard 500. Vanguard was already paying S&P an annual fee of $15,000 a year to model its largest index fund after the S&P 500 and reasoned it could tack a new ETF share class onto the agreement. New product, new licensing agreement, S&P argued. S&P prevailed in court, a big reason that the Vanguard 500 has no ETF share class.

Marketing has never been in the company's blood. Initially Vanguard's ETFs were called Vipers, which stood for Vanguard Index Participation Equity Receipt. "A snake with fangs, that's a great image for Vanguard," is the sarcastic description from Martha Papariello, who now handles Vanguard's relationship with financial advisers.

Here's why you should pay attention to Vanguard ETFs.

THEY'RE CHEAP

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The Vanguard Total Market ETF, with an annual overhead cost of a mere 7 cents per $100, is 2 cents cheaper than the lowest-cost version of the corresponding open-end fund. And to get that 9-cent rate you have to have $100,000 at Vanguard; smaller investors pay 19 cents. Total Market here means a fund that tracks the 3,900-stock MSCI US Broad Market index.

State Street's Spider follows the S&P 500 for a competitive rate (8 cents), but this vendor is often much more expensive for other flavors of ETF. Its Global Energy Index ETF costs 49 cents a year, while the Vanguard Energy ETF costs 22 cents. State Street's ETF for medium-capitalization companies runs up expenses of 35 cents, to Vanguard's 13 cents.

THEY COME IN SMALL BITES

In December Vanguard introduced an Extended Duration Treasury fund, which owns zero coupon Treasurys with maturities of at least 20 years. The minimum investment is $5 million for the mutual fund. You can get a round lot of the ETF mirror fund for $9,930.

You can also, of course, buy zeros directly. But they are expensive to trade. The retail bid/ask spread for 20 Treasury Strips due in 2028--that's $20,000 face amount, now worth $10,100--is in the neighborhood of 4.2%. The bid/ask spread for 100 shares of the new Extended Duration ETF is currently only 1.5% (on very low volume).

Kenneth Volpert, in charge of debt management for Vanguard, developed the Extended Duration Fund and ETF. He hopes in typical Vanguard fashion that small investors will stay away, since zeroes are very volatile. "It's twice the duration of our long bond fund, which is 12 years," he says. "It's risky."

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THEY KEEP UP WITH THEIR INDEXES

Tracking broad stock indexes isn't a difficult task, and all of the large ETF players do this well. But bond benchmarks are far tougher, and here Vanguard shines.

The iShares Lehman Aggregate ETF charges 20 cents a year per $100 and holds 162 securities from 115 issuers. The Lehman Aggregate Bond Index has 9,000 debt issues. Although no indexer owns them all--a lot of the securities are very illiquid--Vanguard does a much better job with 2,923 securities from 469 issuers in its new Total Bond Market ETF, which costs 11 cents. The iShares ETF trails its bogey by 0.35%, three times the shortfall of the Vanguard ETF.

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Book Review Bogle's Beefs Peter Lattman, 11.14.05, 11:28 AM ET NEW YORK -

Do we really need another treatise on how the American financial system went horribly wrong over the past decade? Haven’t we flogged ourselves enough already?

If penned by another author, The Battle for the Soul of Capitalism--with its grandiose title and pretentious American-flag cover art--would appear to be yet another throat-clearing treatise on how to fix the financial markets.

But when the writer is John C. Bogle, ignore the bombast and pay attention.

For years, Bogle, the 76-year-old founder of the Vanguard mutual fund group and inventor of the first index fund, has warned about deep-seated problems in corporate America, particularly the money management business. His laments date back to 1951, when he wrote his Princeton University senior thesis criticizing the fledgling mutual fund business for its high overhead and steep expenses.

That college paper was a seed that decades later blossomed into Vanguard, a $700 billion, low-cost index fund colossus. By passionately preaching a simple concept that we all know but stubbornly fail to acknowledge—most of us can’t beat the market—Bogle has entered the pantheon. Our friends at Time Warner named him one of the 100 most influential Americans (Time) and called him one of the four great investment figures of the 20th century (Fortune). Forbes’ editor, William Baldwin, said of Bogle in 1999, "With messianic zeal he takes on regulators, journalists, competitors, other funds' supposedly independent directors that aren't--anybody who doesn't see the mutual fund business his way.”

Emboldened by the flood of scandals since the bubble burst, Bogle has written his broadest broadside yet. The Battle for the Soul of Capitalism attacks not only mutual funds but also corporations, boards of directors, regulators and investors. No one is immune from Bogle’s scourge.

The usual suspects are present: grotesque executive compensation, shady accounting gimmickry, outrageous fund fees and the folly of short-term speculation. And if you’ve paid attention to the financial scandals over the past decade--meaning you know how much Tyco chief Dennis Koslowski’s shower curtain cost ($6,000)--much of the material will ring familiar.

Unfortunately, the book’s structure resembles a college textbook’s. It’s divided into three sections--corporate America, investment America and mutual fund

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America. Each section then has three subdivisions--what went wrong, why it went wrong and how to fix it. (For a breezier narrative of the 1990s boom and bust, read Roger Lowenstein’s Origins of the Crash.)

But by elevating substance over form, Bogle overcomes the book’s pedantic structure. It springs to life with Bogle’s knack for presenting data in a lively, fascinating and persuasive manner. After reading through reams of data and statistics on how mutual fund expenses fritter away returns, you can’t believe that anyone would invest in anything but a low-cost index fund. (Bogle, though no longer formerly affiliated with Vanguard, has always been his own best salesman.) Though unsurprisingly at his strongest when laying out the failures of the mutual fund industry, he presents a very cogent analysis of such current hot-button issues as the hedge fund bubble and corporations’ faulty pension-return assumptions.

At times, the book reads as if it were titled The Greatest Corporate Governance Reform Writings of the 20th Century. Bogle liberally quotes other financial commentators, philosophers and professors. He knows when to keep quiet and let others--Benjamin Graham on management, Berkshire Hathaway’s Warren Buffett on directors, Joseph Stiglitz on the erosion of moral values--do the talking.

But that’s OK. It is these passages that often leave the strongest impact. Financial journalist Martin Howell’s 24-item list of “red flags” that could indicate problems within a corporation is a real keeper. Bogle is also erudite, sprinkling the text with references to the likes of Mark Twain, Thomas Paine and Alexander Hamilton. Describing how advisers to corporations are blinded by fees, Bogle brilliantly quotes René Descartes: “A man is incapable of comprehending any argument that interferes with his revenue.”

Bogle’s solutions are pragmatic. While he applauds recent reforms like the Sarbanes-Oxley Act and the New York Stock Exchange's new corporate governance rules, Bogle insists that we must do more. None of his recommendations is revolutionary--pay CEOs based on performance, not in comparison to peers; require more transparency from corporations; further rein in the abuse of stock options; create greater access to corporate proxies. But some are unrealistic: Come on, Jack, no matter how hard you try, you’ll never extinguish the speculative excesses in the market!

Conservatives, particularly libertarians, will surely find his regulatory-heavy recommendations repugnant. But Bogle now has recent history firmly on his side. After all we’ve witnessed--Enron, WorldCom, the mutual fund scandal--do right-wingers really, truly believe we can self-regulate?

Do you need further evidence that, in the words of Stigliz, “the pursuit of self-interest does not necessarily lead to overall economic efficiency”? Look no further than Refco. Just before The Battle for the Soul of Capitalism hit

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bookstores, yet another financial scandal shook investors’ faith in our capital markets. After only two months as a public company, the commodities and futures broker imploded after it disclosed that Refco’s CEO hid $430 million of bad debt owed to the company. Where was the oversight? Three of the nation’s top investment banks, three of the nation’s top law firms, a prominent auditor, the SEC, and a top private equity firm (Refco’s largest shareholder) all failed to uncover the fraud.

Bogle might not have too many jeremiads left in him. But one thing Refco makes clear: When it comes to America’s financial markets, there will always be something for him to grumble about.

Despite his Herculean efforts to effectuate change, even Bogle admits there’s a quixotic element to his pursuits. Early on he quotes Harvard Law School professor Mark Roe, in perhaps the most salient passage in the book: “We can resolve the immediate problem, and move on, [but] new problems will arise. We muddle through; we don’t solve them because we can’t.”

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Money & Investing Bogled Backwards Michael Maiello, 02.14.05 In 1993 Vanguard founder John Bogle pressed his investors and the Securities & Exchange Commission to let his company change the fees charged by its funds without seeking shareholder approval. Bogle thought it silly to waste money on a proxy just to lower expenses, and all involved agreed. Turns out the exemption cuts both ways. The company cited the decree when it gave the managers of Vanguard's $27 billion Primecap fund a $12 million raise without asking shareholders for an opinion. Most shareholders will now pay 50 cents in total expenses for every $100 invested in the fund, up from 46 cents. But shareholders can't complain too much. That's a third of the industry average. And the percentage fee paid to the Primecap managers (0.22%) is still half what it was ten years ago. Primecap has handily crushed the S&P 500 over the last decade, beating it by 3.7 percentage points a year. Vanguard estimates that a proxy on the recent fee increase would have cost $1 million. What's noteworthy is the precedent. Bogle's innovation, since adopted by other fund companies, could lead to more fee increases without shareholder approval. Bogle isn't talking publicly.

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THE BOGLE INTERVIEW Intelligent Investing with Steve Forbes

[00:08] Steve: Stocks For Winners Welcome, I'm Steve Forbes. It's a pleasure and privilege to introduce you to our featured guest, Vanguard founder John Bogle. In 1976, Jack created the first retail index fund as an inexpensive gateway for investors to enter the stock market – today Jack is a true legend on Wall Street. My conversation with Jack Bogle follows, but first, One thing that Jack and I share is the belief that common stock investing is a matter of common sense. By investing consistently and patiently in good times and bad, people can achieve their goals. Investing is a step on the pursuit of happiness. It is a step towards forging a fulfilling, creative and philanthropic life. And… as Jack writes in The Little Book of Common Sense Investing: "Investing in equities is a winner's game." It's easy to lose sight of that in a bear market. Sadly, investors choose to buy or sell stocks and funds based on recent performance. They buy when markets are high and feelings are euphoric. They sell when markets are depressed and depressing. Resist the urge to buy and sell the market based on emotions. There's a logic to sticking with it. Over the last 10 years, a broad portfolio of stocks, assuming no new investment or reinvestment of dividends, has likely given you a negative return. This is discouraging. But it is also unusual. Since 1928 the average annual return of the stock market has been around 10 percent. For the market to continue to deliver its average historic return, performance will have to improve. Selling now is a sure way to miss it. "Cast your lot with business," writes Jack Bogle. His numbers make sense because his reasoning is sound. Business has improved lives and raised living standards in the United States and around the world. Wouldn't you want to invest alongside that? And now, my conversation with Jack Bogle… [02:10] When's The Recovery? STEVE FORBES: Well, thank you very much, Jack, for joining us. And I have to start off, since you've seen so much and have warned about the kind of

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excesses that we see from time to time, and none like this certainly in my lifetime. How long will it be before we get a real recovery? And is this the time, corollary question, for wise investors to come in, in a disciplined way, because they may look like idiots for a while as the market turmoil continues? Over time, markets do recover. JACK BOGLE: Markets do recover. The mistake we make I think, Steve, and it's wonderful to be with you again. The mistakes we make as investors is when the market's going up, we think it's going to go up forever, and when the market goes down, we think it's going to go down forever. Neither of those things actually happen. Doesn't do anything forever. It's by the moment. So there are two pretty different things about the timing, I think. One is to separate, very definitely, the economy from the stock market. And I would look for a more extended time to take to recovery from this mess that Wall Street and other people have gotten us into over the last eight, ten years. It's not going to be a quick recovery. It's spreading into the economy in a much more rapid way I think than anybody expected. And if the economy starts to recover in a year and a half or two years, I think we'd be we'd be pretty well served. You don't get over this kind of a disease in a very short time. The stock market, of course, is a totally different idea because the stock market tends to anticipate. And what people who are so bearish on the markets, and I've never seen, I don't think, quite as much bearish as we see now, don't realize that a 50-percent decline, roughly 52 percent from the high to the low creates huge value. And they don't realize the dividend yield when all this started in 2000, that was the beginning of the end, was 1 percent, and now it's 3 percent. Well, that's a 200 basis point improvement, 2 percentage point improvement in future returns on stocks. Stocks back then, early 2000s, were selling at almost six times their book value of all that plant and equipment and cash and everything else they had, maybe even some patents and good will. And now they're selling at about 1.8 times that value, a tremendous difference. A level of attractiveness that we really haven't seen since the early 1980s, mid-1980s might be fair. And from here, I think it's easily possible that with the earnings quite depressed, depending on how we measure them and count them, that earnings could grow at 7 percent a year, faster than the long-term norm of 5 nominal earnings growth. And if earnings grow at 7 percent from here over the next decade and there's no point. STEVE FORBES: That's 100 percent. JOHN BOGLE: 100 percent, right. You know the rule of 72, divide the number into 72, any number you want, and that's how long it will take your money to

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double. So earnings could easily double from these levels, these depressed levels, relatively depressed levels over the next 10 years. So I don't mean to be a Pollyanna about it because we are facing incredible challenges in the economy of the U.S. and the economy of the globe, but the stock market, we never know whether it's over-discounted or under-discounted or got exactly right its anticipation. But I'd say it's probably over-discounted, the stock market is over-discounted, the economic troubles, the deep economic troubles we're going to have for some time. STEVE FORBES: Because really as you point out, dividends at 3-plus percent, you look at Treasuries, they're yielding just above 3 percent, we haven't seen that since, what, post-World War II. JOHN BOGLE: Well, I think the year is about 1958 was the last time that yields on stocks were higher than the yields on Treasuries. So it's quite remarkable. And if you go into short-term treasuries, they're now auctioning our valued nation's debt off for an interest rate of zero. And I think we could agree, that's a very low interest rate. STEVE FORBES: Japanese-like. JOHN BOGLE: Yep. [06:09] Emotion Is The Enemy STEVE FORBES: Well, this gets to an important thing, and you've hammered on this for years. Your advocacy of indexing is how do you get people to realize their emotions are their enemy? When the market goes up, is it too late to get in? JOHN BOGLE: Yeah. STEVE FORBES: And then they take unnecessary risks. When the market goes down, is it too late to get out? JOHN BOGLE: Yeah. STEVE FORBES: How do you get people to overcome those kinds-- JOHN BOGLE: Well, the first thing you have to think about is, and this is an issue that I've almost never heard discussed, Steve, and that's the first question you have to ask yourself is: Am I an investor, or am I a speculator? And an investor is a person who owns business and holds it forever and enjoys the returns that U.S. businesses, and to some extent global businesses, have earned since the beginning of time.

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They have capital, they earn a return on their capital, and that capital grows over time. It's not complicated. That's the business of investing. Speculation is betting on price. I think I can buy this for 10 and sell it for 12 or 14 or 20 or 100. Speculation has no place in the portfolio or the kit of the typical investor. Speculation leads you the wrong way. It allows you to put your emotions first, where investment gets emotions out of the picture You own these business, they're still sound, if the market doesn't think they're worth as much as they were, well, pity, the market doesn't know everything. So that's the first thing. The second thing is how do you minimize the role of emotions because, of course, even the hardest-skinned, thickest-skinned investor has an emotional component to his or her behavior. And the way I think you do it is make sure that your asset allocation is intelligently set depending on who you are and where you are in life. A good rule of thumb that I've used for a long time is have your asset allocation to bonds equal to your age. So if you're 20, you would be 20 percent in bonds, maybe that's a little high if you're 20, but if you're 80 don't even want to get into the possibility anybody would ever live to that ancient age, but you would be 80 percent bonds. And so in this year that we're having right now, that kind of a portfolio is probably down less than 15 percent. You know, not fun, but not debilitating as it would be if you were 100 percent in equities. So get your asset allocation right. And then if you're still working, still putting money away, you want to continue to put money away and just do it regularly every month and don't worry about what the market does on that day, and just do it time and again. I think that is, for almost all of us, a better strategy than saying, “well, we thought that the end was here, or near, and now we know it's not, so I'll take everything out of my bond account and put it into my stock account.” I don't know, no, I don't know anybody who's been able to do that right. And Steve, actually, I don't even know anybody who knows anybody who has been able to do that right over time. STEVE FORBES: Outside of summer cocktail parties. JOHN BOGLE: Yeah, there's a lot of talk about it. STEVE FORBES: Yeah, everyone's a genius. JOHN BOGLE: I was looking more at the action. [09:20] Classic Indexing

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STEVE FORBES: Well, when you make the distinction between speculation and true investing, that gets to the whole thing you're seen as the apostle of index funds. And the nice thing about index funds is because you have so many businesses, you don't have to worry, “Is this one right or this one wrong?” You've spread your risk into the market as a whole. JOHN BOGLE: Yeah. STEVE FORBES: But indexing, first, remind us of why indexing is good, and then I want to get into how you think it might have been perverted in recent years, because now there seem to be as many indexes as there are equities. JOHN BOGLE: You are exactly right. Well, to me, Steve, classic indexing is owning the entire U.S. stock market. When I started that first index fund way back in 1975 a long time ago, it happened to be called Bogle's folly, everybody said it wouldn't work. How could it not work? But we used the S&P 500 index, and that's almost as good very close to as good as the total market, but sometimes small caps and mid caps will do better, sometimes worse, in the long run, it doesn't matter. So I think the total U.S. stock market is the preferred choice. I'm a little apprehensive, we can talk about maybe later, the idea of international diversification too, but that's an option to index the markets outside of the U.S. if you like that strategy. I have some problems with that strategy. So let's just look at the U.S. and say you own every company in the U.S. and it's more important, I believe more important for indexing the advantages of indexing are more important today than they've ever been before. Because what are we dealing with today that's different? One, a global financial crisis and trying to pick out what sectors are going to do well and what sectors are going to do ill in the middle of this global financial crisis is simply I don't think something that any of us can really do very well. And number two, we have global competition and we didn't have that 25, 50 years ago. It's very extreme, and that adds to the rate of change and the failure rate of U.S. companies. And third, we have this technological revolution where a company that has the world at its fingertips on day one lost its franchise on day two because someone else has an idea just a little bit better. So with those three reasons, owning everything in a market, you will own the good ones and the bad ones, you will own those that are creatively destroying others, and those that are being using Schumpeter's wonderful phrase, "the victims of creative destruction."

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And so you own everything and hang on. Now the advantages of that are really simple. One, you can do it for almost nothing. The cost of indexing can be done for about say 5 to 10 basis points around a tenth of 1 percent, let's say. So you eliminate all those management fees which don't get you anywhere. And number two, it's very tax efficient because it's not turning over the portfolio. Number three, its turnover cost efficient because the index doesn't have that 5, 6, 7 percent turnover. [12:18] Wall St. Hates Jack STEVE FORBES: This gets to something that, I love some of your colorful phrases, is if indexing was widely adopted, the financial services industry would be a fraction of the size it is today. JOHN BOGLE: Small fraction. STEVE FORBES: You used words like "croupiers" and things like that. Can you go into that how much money we spend on what you think is services that we, perhaps, really don't need? JOHN BOGLE: When you think about it this way, Steve, for a minute, the financial markets generate STEVE FORBES: And how you came up with the word "croupiers" for some of these guys. JOHN BOGLE: Not a lot of people on Wall Street here really want to be seen anywhere near me, but I start off with how does the financial system work? What can we not control, we investors and speculators together? We cannot control the return on the stock markets, the bond markets to deliver. They're going to do it without any help from us. So let's assume, for the purpose of argument, to make the point clear, that stocks deliver, let's say an 8 percent annual return. So we all divide up all investors as a group divide up 8 percent. I mean, the mathematics are not exactly complicated. Then the croupiers take their 2 1/2 to 2 percent a year, which is around the cost of the financial system. So we earned 5 1/2 percent, maybe 6, in an 8-percent stock market. Well, that doesn't sound terrible. I mean, it certainly doesn't sound very good. But compounded, we're back to Einstein, the miracle of compounding interest, it turns out it's the miracle of compounding returns is overwhelmed by the tyranny of compounding costs. Because when you get out a compound interest table maybe some of your viewers will want to do that and compare 8 percent over let's call it an investment lifetime of 50 years compared to 5 1/2 percent, which is the after after-cost return, and I haven't even taken taxes out of that second return, it would make it much worse.

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It turns out that you get about you who put up 100 percent of the capital, you took 100 percent of the market risk, are getting about 25 percent of the market's return. And the croupiers, who of course put up zero percent of the capital and took zero percent of the risk are getting 75 percent of those compounded, long-term returns. So to not pay attention to the cost is probably the biggest dumb mistake that investors can possibly make. So indexing triumphs because it doesn't have transaction costs, it doesn't have management fees, it's extremely low operating expenses, it has no sales loads, about 2/3 of all funds you've got to pay 5 percent to get in and 5 percent every time you turn around. And so you get costs out of the equation. And when you diversify to owning everything you're going to capture the return earned by business. And brings me to another statement that I put in one of my books, which I really like, and that is when you think about these variations in this most speculative of all stock markets in U.S. history, it turns out that the stock market is a giant distraction to the business of investing. And that's because of croupier costs and speculation. Because speculators they obviously break even with one another. I mean, there's somebody on the other side of every one of those trades. But the only sure winner is not A or B, Peter or Paul, it's the man in the middle, the croupier, Wall Street, and Wall Street's costs, a few years ago, were around $600 billion a year. They took their $600 billion and you got what was left because the investor is inevitably at the bottom of the food chain of investment returns, whereas the market creates a certain return. STEVE FORBES: Now that $600-billion number is staggering. I could see sixty. How do you head up to that over time? JOHN BOGLE: Well, no, that's one year. One year. That would be at that rate, $6 trillion every ten years in a stock market that's presently worth $9 trillion. A little excessive, one might say. I mean, overwhelming. And what it is, I mean, we just published data I wouldn't swear to its precise accuracy, but we know that the mutual fund industry takes around $100 billion a year, no argument about that. We look at the securities industry data, and Wall Street, you know, direct Wall Street, investment banking and brokerage, takes in the in order of magnitude $300 billion a year. Hedge fund managers, up to another $50 billion, investment advisors to individuals take X, variable annuities have another cost, and you add it all up, and you get to about $620 billion. It may be a little on the high side, but it's not 100 billion, and it's not 200 billion. You know, maybe if I'm wrong, and nobody really knows the number, but if I'm wrong, maybe it's as low as 500 billion, and of course, it could be more. And equally, of course, it doesn't include the taxes that are paid on all those transactions. And in a giant bull market, those taxes probably cost another, let me just say for the purpose of argument, three to 500 billion a year. And that's everybody owns the same stocks before and after, but Uncle Sam.

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STEVE FORBES: Sound worse than Las Vegas. At least the house lets you get 90 cents on the dollar back. JOHN BOGLE: Well, in Las Vegas, we all know that it's the croupiers that win. At the racetrack, it's those who control the handle who win. State lotteries, does anybody think the participants in the lottery win? No. The state wins. STEVE FORBES: Big time. JOHN BOGLE: Yeah, big time. [17:42] Too Many Indexes STEVE FORBES: Now, getting on indexing from what you've said, you'd only need maybe a handful of index funds. You like the U.S., and then we'll discuss international in a moment. But now there are tons of indexes, not to mention exchange traded funds. First, proliferation of index funds. What are your thoughts on that? JOHN BOGLE: Well, I'd say to express it with my usual reserve, STEVE FORBES: They have index funds for neckties now. JOHN BOGLE: It's ridiculous. Yeah, it's ridiculous. Classic indexing, as I call it, is owning an entire giant sector of the market. Let's say all U.S. stocks or all non-U.S. stocks and holding on forever and doing it at low cost, eliminating the transaction impact that we talk about. And it happens that this year that kind of an index fund, let's call it for the purpose of simplicity the S&P 500 index fund is outperforming about 80 percent of all equity funds, 80 percent. Think about that. In fairness, international has done badly and small cap has done badly. So if you look just the large cap index funds, which is more what S&P would be like, the S&P 500 index is outperforming about 2/3, maybe 70 percent of all the large cap comparable funds. So it's having a banner year by doing it right. What we have here is this whole idea of what I call indexing nouveau. Index funds that are very narrow, sometimes microscopic sectors. Small cadre of funds who have new kinds of indexes. Don't market weight like the Standard and Poor's 500, don't weight your index by the market capitalization, weight it by our idea of who's going to earn the most or who's going to pay the most dividends, whatever it might be, they aren't working out very well this year either.

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And then you can isolate out a single country index. You can buy commodity indexes. Only down 55 percent this year. It's quite unbelievable. And ETFs are index funds, exchange traded funds are index funds that you can trade all day long in real time. And that's the way they are average, they are advertised. And Steve, when someone says you can trade the S&P 500 index all day long in real time, I can only ask, “What kind of a nut would want to do that?” I mean, I would say, “Get a life.” You know, take your wife out to a movie, it's better to take the kids to the park. Read a book if all else fails. But trading the S&P 500 index all day long? And trading narrow sectors is even worse. So it's a throw back to Wall Street entrepreneurs because they, I believe, I don't mean to be unfair about this, but the reason all these new things are started is not to enrich the clients of the investment system, but to enrich the marketers and entrepreneurs and promoters of the investment system. And that's how we got into credit default swaps, that's how we got into collateralized debt obligations, always a new, easy way to do better. Well, those latter fixed-income things are not easy ways, we now know, and neither have the index funds, the ETF funds have worked very well. [20:49] ETF Abuse STEVE FORBES: On the ETFs, if somebody used it right because they are very low cost you could, in effect, sometimes they have lower costs than regular mutual funds. JOHN BOGLE: Right. STEVE FORBES: So if you just took it and threw it in the drawer, that would be fine, but that's not what people do. JOHN BOGLE: No, exactly. I mean, if someone said they wanted to buy the total stock let's say the Vanguard total stock market ETF and not trade it, it's just as good, it could even be a little bit better. We don't know that, time will tell, but it's not going to be much different than the standard Vanguard total stock market index fund. And that's a perfectly intelligent thing to do. Reasonable people disagree on the extent to which these ETFs are used in that specific kind of case. I think I'd be surprised if it was 10 percent used in the proper way and 90 percent used in the wrong way. [21:36] Investing Abroad STEVE FORBES: Now, on international, if somebody feels in this globalized market that they want to have exposure overseas, are there proper index funds, you think, where people can do it in a way and get the same kind of benefit you do with the S&P 500 or the Wilshire 5000 or whatever?

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JOHN BOGLE: If you do it in the long run, I believe that there's not any inherent reason that diversified international markets and maybe emerging markets even a little bit better, won't do roughly what U.S. markets do. You know, the markets, the financial markets, I hardly need to tell you, the king of all this, how financial markets work, but they anticipate. And so they're priced to capitalize on future earnings growth whether it's the U.S. or emerging markets or the developed markets outside of the U.S. So international as such is not bad. The problem with international is two. One, when people get interested in international, it's not because they want a diversification, but because they have done very well in the past. People talk about the benefits of less correlated asset classes, but they talk about it after international has done well. So a year ago, the previous year, two years, roughly in 2007, something like 85 percent of all equity mutual fund capital flow in something like $400 billion went into international funds, 85 percent went international. And then, of course, when 2008 came along we have the U.S. market, probably the best-performing market in the world off about 35 percent, the developed international off 45 percent, the emerging markets off 55 percent, and as a wise man said about international diversification a long time ago, Steve, the problem with international diversification is it lets us down just when we need it the most. It falls apart in down markets. STEVE FORBES: That gets to a point you make in terms of when people put together these new products, it always works in the past. JOHN BOGLE: Yeah. [23:43] Historic Returns STEVE FORBES: But doesn't mean it's going to work in the future. JOHN BOGLE: It's so ridiculous, and so much of the system is based on this, Steve, that for example, the long-term return on stocks has been 9 1/2 percent. That's a 4 1/2 percent dividend yield and a 5 percent earnings growth. The 9 1/2 percent means nothing when the dividend yield is 1 percent. It means that you've lost 3 1/2 percentage points of future return. So instead of 9 1/2, the future return at a 1 percent yield level should be about 6 percent. Nobody takes this simple, self-evident fact into account when they look at history. So I think Lord Keynes warned us about this in 1936, that don't pay any attention to past returns until you have examined the sources of those returns. And for stocks, it's dividend income, earnings growth, and then that's what I call adding them together, investment return, and speculative return is a bet that people will pay more for a dollar of earnings or less at the end of a given period. But over time, speculative return turns out to be zero.

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[24:46] Unknown Unknowns STEVE FORBES: Now, best financial lesson you've learned, you've always said, is be ready for surprises. JOHN BOGLE: Yep. The other one I mean, there are always surprises. I guess we have come to call them after maybe Don Rumsfeld the "unknown unknowns" as compared to the "known unknowns." And it's been popularized by the idea of a black swan. Originally the idea that just because you have never seen anything but white swans doesn't mean a black swan doesn't exist. Of course the fact they were found later on in Australia is a kind of tragedy to the metaphor. But that's another story. And the black swans are quite likely, these unimaginable events, with a huge, a very non-recurrent, maybe recur every 50, 75 years. When those things happen, of course they're unexpected. Of course we can rationalize them later, but they are much more likely to happen in the financial markets rather than in the economy itself. The economy doesn't usually move in fits and starts. I mean, that's why we compare this economy that we're in right today with 1929. Well, that's an 80-year gap between those two really monumental economic events. I don't think, by the way, to be clear, that we're facing a depression this time, but I think we're facing a more serious recession than I happen to have seen in the 10 bear markets that I've witnessed. [26:19] The Agency Society STEVE FORBES: So what do you think is the one big, misplaced assumption in business today? JOHN BOGLE: Biggest misplaced assumption in business today? Well, let me give you a couple. What I'm really bothered about is we haven't taken any account in our overall financial system and I have never seen anybody make this point, that we have moved distantly away from an ownership society into what we now have as an agency society. And that is when I came into this business back in the early 1950s, about 8 percent of stocks were owned by financial institutions, and 92 percent by individuals. Today, institutions own not 8 percent of the market but 74 percent. And individuals own the remaining 26 percent. So we have institutions behaving just as Adam Smith warned they would, handling other money other people's money in a very different way than they would ever dream of handling their own. So the misplaced assumption is this is still the same old, same old thing and we have this whole new institutional element where these institutions, I regret to say,

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but I will say it nonetheless, are looking after their own financial interests before the financial interests of the principals, princi-pals whose interests they are really bound to observe first. And that's a tragedy, and we have to do something about it as a society to establish one of my recommendations, which is the one of the less popular ones, and it's a long list of unpopular ones, is to have a national standard of fiduciary duty for those handling other people's money. STEVE FORBES: This gets to a point about Wall Street itself. A number of years ago, firms started to go public, public shareholders. Do you think we're going to go back to an era, and is there any way to bring it about where you have partners' money at stake, and therefore, you know when you take these out-sized risks, it's your money that's at risk and not somebody else's. JOHN BOGLE: Yeah, that's actually a very, very important extension of the point that we were just talking about, and that is that nobody seems to have recognized that these investment bankers, basically relatively small firms, would never have had 33 times leverage in a portfolio that's a long way from a portfolio of treasury bills, believe me, of assets. They don't want to take the blame for not knowing how to value those assets, but I don't know who else to blame it on if you buy an asset that can't be valued. So the transfer of Wall Street from private ownership to public ownership has been a big step backward. In my previous book, one of my previous books, which is called The Battle for the Soul of Capitalism, I had one little section entitled, “Bring Back Glass-Stiegel.” Bring back the separation between banking and investment banking. It served us well for 70 years or so, and the way the system is going today, that can't be brought back. There's barely an investment bank that's independent left, couple of big ones, as you know, Morgan Stanley and Goldman Sachs, but the other investment banking and brokerage firms are now part of giant banks. And so we have this tremendous concentration. And the only way you're going to be able to, I don't know any way to do that, although it may happen naturally in a really competitive capitalistic economy and that is you've got to have a smaller unit size for financial institutions if you're ever going to have a private partnership. How can regulation compensate for this tremendous change in the way that banks and investment banks are handling other people's money? This tremendous amount of public ownership where the idea the bankers, very relevant again to just what you've said, the bankers forgot to look at their own balance sheets. You know, when we were young, when I was young, anyway, balance sheet was the first thing you look at. They're looking at their profit and loss statement and they're trying to make more earnings by fair means or foul, and they often do it by fair means or foul, because that takes up the value of their

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compensation, their year-end bonuses, their stock options, which they exercise and sell stock immediately. STEVE FORBES: Which leads to a question: Should there be provisions now we're starting to hear the word "callback." Get a bonus one year, but if you've done trades that turn out not to have worked out well in two or three years down the road, you've got to give it back. JOHN BOGLE: It's a good idea conceptually. It's like an awful lot of good ideas, it's hard to know exactly how to make it work. There is, as you may know, actually, a callback section in Sarbanes-Oxley. If you've misstated, if your company's earnings are restated you have to give back the earnings that you were paid on those higher earnings. But it requires evidence of fraud. And that's very hard to prove. And so conceptually, I like the idea of callback, both for the traders, but also for the people that are running the firms. STEVE FORBES: So maybe you have a provision where you get the bonus over four years or something? JOHN BOGLE: Sure. You know, or even longer. I mean, I don't see any reason not for not stringing it out, and maybe that would get investors to hold shares for longer because the average, you know, the turnover in our exchanges suggests that the average shares it's going to be about 340 percent this year. In 1929, it was 140 percent, and in my early years in this business in the '50s and '60s, it was about 30 percent a year. So this is the greatest orgy of speculation that we've ever had in the financial history of the U.S. STEVE FORBES: So sort of a financial version of an X-rated movie, I guess. JOHN BOGLE: Yeah, exactly. [31:47] Self Interest Can Save Us STEVE FORBES: So what is what is your bold prediction for the future? You've seen so much, you're seeing so much. You've, obviously, thought a lot about it, written about it. JOHN BOGLE: My biggest prediction for the future is that people are going to start looking after individual investors, are first going to decide speculation doesn't work and if they think it still does work, they're not going to have any money left, so they won't be part of the market participants group. But realize the economics of investing and act if investors, Steve, would simply act in their own economic interest, none of this would happen. If institutional investors would act in the economic interest of their clients, I'm coming back to that point, and not their interests as principals in the firm, or agents of these investors, I should say,

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that we need to change that, but like mutual fund investors should buy intelligent mutual funds. I would argue index funds or something like index funds, but in any event, mutual funds that are, in fact, investing rather than speculating. The list is not laced with such funds that operate at low cost rather than high cost, that sell at no load rather than load, that have low portfolio turnover rather than high, and have high tax efficiency rather than low. If people would look at those things and think, what is best for me and my family over the next 30, 40, 50 years, or 20 years, whatever the period might be, that will bring about change. However, that's going to take a long time, and as we now know, time is money, we don't want to spend $600 billion a year forever. So I believe strongly that we need to take a whole look at the financial system and get back to forcing trustees of other people's money, pension, particularly pension fund managers and mutual fund managers to put the interests of their clients first, and that's this whole fiduciary duty idea, and that's not going to be an easy thing to get done. This industry hates the idea, and I think they're just going to have to get used to it. So the big idea is let's make the system start working for the investor on Main Street and stop working for the principle benefit of the marketers and innovators, whole people of all this complex financial system who put it together of Wall Street. And if we can get Main Street first and a democratic society a democratic, and I should say capitalistic society, that's the way it should work. The market should clear at the best clearing point, and the best clearing point is not today. Too much taken out of the system. STEVE FORBES: I just can't resist asking one final question. And that is: People are very careful with their money when they buy a car, they go online, find out what the prices are, they have coupons when they go to the supermarket, and yet when it comes to money management, you say with funds, by golly, 1,000 here, 2,000 there, a percentage here, a percentage there, what is it about human nature that accounts for that? JOHN BOGLE: Well, what it is about human nature is I think our self confidence that basically says, look, I don't give a darn about your index fund that charges a tenth of one percent, I'm going to buy a fund that's charging me, all-in, sales charges and so on, turnover costs, 2 1/2 percent a year because they will do more than enough better. As one of the senators asked me when I testified in Washington, I think it was Senator Sununu, said, "Wait a minute, wait a minute, here, wouldn't you rather pay 2 1/2 percent a fund for a fund that made 25 percent a year than a tenth of one percent for a fund that made 10 percent a year?"

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Well, of course I would, Senator, but I don't know how to pick that other fund, I don't know how to know its risk, and what happens is we chase past returns. And past returns overwhelm cost. There's always some wild man or woman out there that's outperforming the market itself. So I think investors have to have a little less self confidence and realize to put it in a very harsh way, that the mutual fund industry in particular is not only an industry where you don't get what you pay for, it turns out, examine the data, that you get precisely what you don't pay for. And therefore, if pay nothing, you get everything. You get the market's return if you don't pay anything to get it. So the index fund is giving you the market return less a tenth of one percent, and that has to be the answer. And I feel a little guilty talking about index funds because I did create that first one all those years ago, but facts are facts, math is math, and quoting Brandeis here, the relentless rules of humble arithmetic remain the relentless rules of humble arithmetic. STEVE FORBES: Thank you very much. JOHN BOGLE: Great to be with you. It was fun. STEVE FORBES: Thank you.