Bogle’s Big Mistake

The world lost a legend this week. Jack Bogle had a greater impact on the average investor than anyone who ever lived.

Bogle, however, was not an overnight sensation. The index fund, which he is best known for, wasn’t created until his fifth decade on the planet.

I wanted to share the challenges he overcame on his way to cementing a place on the Mount Rushmore of finance with this chapter from my book, Big Mistakes: The Best Investors and Their Worst Investments.

Rest in peace, Jack.

Source: WSJ 


Sometimes in life, we make the greatest forward progress by going
backward.

—Jack Bogle

The Vanguard 500 Index fund is the world’s largest mutual fund, with
$292 billion in assets. That’s 292 followed by nine zeros. How do you
get to be so gigantic? Start with $11 million and grow 29% per year for
the next 40 years. To give you an idea of how much money $292 billion
is, that is, if you were to stack it in hundred dollar bills, it would stretch
198 miles, which is just about the round-trip distance from New York City
to Vanguard’s headquarters in Valley Forge, Pennsylvania.

Index funds have picked up incredible momentum in the past few
years. Since the end of 2006, active investors have pulled $1.2 trillion from
active mutual funds and plowed $1.4 trillion into index funds.1 Vanguard
has been the biggest beneficiary of the tidal wave of change of investor
preference. The only mutually owned mutual fund structure in the world,
Vanguard had the largest sales ever by a fund company in 2014, in
2015, and again in 2016.2 But despite the ubiquity of index funds
today, it was not always this way. The idea that investors should settle for
“average” returns was once heresy and these funds were often referred to
as Bogle’s folly.

The effect that Jack Bogle has had on the mutual fund industry and on
all of finance cannot be overstated. Vanguard is now ubiquitous, managing
more than $4 trillion in client assets. But the idea of capturing “just” mar-
ket returns, however, was not something that took off right away. In fact,
the index fund was met with resentment from the investment community
and apathy from investors. The goal for Vanguard’s underwriting of the
First Index Trust in 1976 was $150 million. When all was said and done,
they raised just $11.3 million, a 93% shortfall from their desired target.3

The lesson we can learn from one of the most influential investors of
all-time is that investing is a long journey, often lasting a lifetime. It is filled
with success, failure, hopes, dreams and everything in-between. Jack Bogle
is on the Mount Rushmore of investing, and what he will be remembered
for, the index fund, was something that he didn’t create until three years
shy of his 50th birthday!

Twenty-five years before the index fund was created, in his 1951
thesis at Princeton University, Bogle wrote mutual funds “should make
no claim to superiority over the market averages.” He studied the recent
performance of mutual funds and discovered that they trailed the index
by 1.6% each year. Later that year, Walter Morgan, a Princeton alum
and the founder of the Wellington Fund, hired him. Morgan created
one of the first actively managed balanced mutual funds in 1928, with
$100,000 (originally under the name The Industrial and Power Securities
Company). Almost 90 years later, it is the oldest balanced fund in the
United States. The Wellington Fund was one of the few funds to survive
the Great Depression, which it owes to the prudence of its founder.
The fund had 38% of its assets in cash heading into the crash of 1929.
Viewed as a responsible steward of capital, Wellington would gain
momentum throughout the Great Depression as many of its competitors
fell by the wayside.

When Bogle was hired in 1951, the Wellington Fund managed
$140 million. Today, at $95 billion, its assets have grown by 95,000,000%,
or just under 17% a year for the past 89 years. But the journey between
then and now was hardly a smooth ride.

In 1964, just before its assets would peak at $2 billion, Walter Morgan
said, “The name Wellington had a magical ring, a sort of indefinable air
of quality about it that made it almost perfect as a name for a conservative
financial organization.” The conservative financial organization would
quickly lose its way. Performance sputtered, the dividend declined, and
fund assets cratered to $470 million, a 75% collapse!4

The fall from grace happened under Bogle’s watch. He was a member
of the investment committee from 1960 to 1966, and in 1965, at just
36 years old, he was handpicked by Morgan to succeed him as the president
of the Wellington Group and in 1970, he was named CEO.

Performance first started to fall behind as Bogle’s responsibilities grew.
From 1963 to 1966, the flagship Wellington Fund gained just 5.1% annu-
ally, well below the 9.3% return of the average balanced fund.5 As the
environment started to heat up and the conservative nature of Wall Street
was transformed by the first generation of new blood to enter since the
1920s, management decided it needed to do something to keep up with
the changing times. “Lured by the siren song of the Go-Go years, I too
mindlessly jumped on the bandwagon.”6

Their decision to keep up with the times led them to merge with a
young Boston firm, Thorndike, Doran, Paine & Lewis Inc. Bogle said the
move was designed to achieve three goals:

1. Bring in managers from the “new era” who could return their perfor-
mance into top results

2. Bring a new speculative growth fund (Ivest Fund) under the Wellington
banner.

3. They wanted to gain access into the “rapidly growing investment coun-
seling business.”7

The merger of these two companies was an odd pairing; it would
be like Vanguard purchasing a crypto-currency trading firm today. The
following is an excerpt from The Whiz Kids Take Over, an article that
appeared in Institutional Investor in 1968: “Wellington was founded in
1928 with a balanced portfolio of common and preferred stocks and
high-grade bonds, with the objective of providing investors with stability,
income, and a little low-risk growth to keep pace with inflation… Ivest,
on the other hand, was established in 1961, in effect, to make the
most of those very fluctuations that Wellington was originally designed
to minimize.”8

The merger turned the Wellington Fund into the antithesis of what
led to its long-standing success. From 1929 to 1965, Wellington’s equity
ratio averaged 62% and its beta averaged 0.6.9 But with the new kids in
town, turnover went from 15% in 1966 to 25% the next year, and stocks,
which averaged 55% for a balanced fund, approached 80%.

Shortly after the merger, Bogle was feeling pretty smart about their
shrewd business decision. In a recent interview, he said, “The first five
years you would have described Bogle as a genius. And at the end of the
first 10 years, roughly, you would have said: the worst merger in history,
including AOL and Time Warner. It all fell apart. Their management skills
were zero. They ruined the fund they started, Ivest. They started two more
and ruined both. And they ruined Wellington Fund.”10

Like so many other funds, Wellington got seduced and ultimately
chewed up and spit out by the go-go years of the 1960s:

The term “go-go” came to designate a method of operating in the
stock market – a method that was, to be sure, free, fast, and lively,
and certainly in some cases attended by joy, merriment and hubbub.
The method was characterized by rapid in-and-out trading of huge
blocks of stock, with an eye to large profits taken very quickly, and the
term was used specifically to apply to the operation of certain mutual
funds, none of which had previously operated in anything like such
a free, fast, or lively manner.11

Investors found out how their “balanced fund” would be transformed
into something completely unrecognizable in the 1967 annual report.
Walter Cabot, the new portfolio manager, wrote:

Times change. We decided we too should change to bring the portfo-
lio more into line with modern concepts and opportunities. We have
chosen “dynamic conservatism” as our philosophy, with emphasis on
companies that demonstrate the ability to meet, shape and profit
from change. [We have] increased our stock position from 64 per-
cent of resources to 72 percent, with a definite emphasis on growth
stocks and a reduction in traditional basic industries. . . . A strong
offense is the best defense.12

This was written as the go-go years were approaching their apex, the
timing could not have been worse. John Dennis Brown, author of 101
Years On Wall Street, described 1968 as “the most speculative year since
1929.”

The go-go years came to a bloody ending in 1969, with the Dow falling
36% in 18 months and individual issues falling much farther. But the stock
market bounced back, and the bloody memories were quickly erased in
investors’ minds. The next things to take hold on Wall Street were the nifty
fifty and the “one-decision” stocks. Portfolio managers would no longer
rapidly trade these growth stocks, instead they would invest in blue chips
like IBM and Disney, and no price was too rich.

But when the air came out of the stock market, they learned the
meaning of not confusing brains with a bull market. “The merger that I
sought and accomplished not only failed to solve Wellington’s problems,
it exacerbated them.”13 Ivest, which is one of the reasons they sought
TDP&L, lost 55% of its value, compared with a decline of 31% for the
S&P 500 over the same time. But the carnage wasn’t just limited to Ivest.
They had started a few other funds, but they were no better off. When the
markets tanked, all of them dropped far below the S&P 500. The Explorer
Fund was down 52%, the Morgan Growth Fund slid 47%, and Trustees
Equity Fund was down 47%. By 1978, the Trustees Equity Fund had
folded and, as Bogle noted, “a speculative fund – Technivest – that
we designed to ‘take advantage of technical analysis’ (I’m not kidding)
folded even earlier.”14 You read that right, Jack Bogle, the creator of the
index fund, was the CEO of a company that ran a strategy based on
technical analysis.

Of all the damage that would be done, the one that cut the deepest
was inflicted on their crown jewel, the Wellington Fund. It lost 40%,
which was 80% of the decline in the S&P 500. Bogle described this as
a “shocking excess relative to Wellington’s long history. The loss would not
be recouped until 1983, 11 long years later. The ‘strong offense’ proved no
‘defense’ at all.”15 The incredible track record and reputation they had
built over the years was in jeopardy. The average balanced fund gained
23% for the decade, while Wellington’s total return (including dividends)
was just 2%.16

Bogle looks back on this period of his career with disgust. “I can hardly
find words to describe first my regret and then my anger at myself for hav-
ing made so many bad choices. Associating myself – and the firm whose
leadership I had been entrusted – with a group of go-go managers.”17
The blame for the disastrous performance fell on Bogle. He was fired as
CEO of Wellington Management in 1974 but convinced the board to let
him stay on as chairman and president of the Wellington Fund.

Abject failure would give birth to the most important financial innova-
tion the world has ever seen, the index fund. In 2005, at a Boston Security
Analysis Society even, the great Paul Samuelson said:

I rank this Bogle invention along with the invention of the wheel, the
alphabet, Gutenberg printing, and wine and cheese: a mutual fund
that never made Bogle rich but elevated the long-term returns of the
mutual-fund owners. Something new under the sun.18

Bogle had taken all of the lessons he learned and focused his atten-
tion into a better way of doing business. By September 1974, he and his
team had completed months of research. He was able to bring that to the
directors of the funds and convince them to form the Wellington Group,
a specialized staff dedicated to Wellington and seven other selected funds.
The eight Wellington funds were wholly owned by the funds themselves,
“operating on an at-cost basis- a truly mutual mutual funds structure, with-
out precedent in the mutual fund industry. The name I chose for the new
firm was The Vanguard Group Inc. On September 24, 1974, Vanguard
was born.”19

After 16 months of trying to convince the board to create an index
fund, the First Index Investment Trust was born. Bogle had shown them
the evidence, that over the previous three decades, the S&P 500 index
averaged 11.3% growth per year, while the funds trying to beat it earned
just 9.7%. The rest is history. Well, sort of. Wall Street wasn’t ready to
embrace the index fund or stocks for that matter. When they launched
in August 1976, stocks were just wrapping up a lost decade. They were
trading at the same levels as they had 10 years ago and just experienced
the worst bear market since the Great Depression. But determined and
sure that he was onto something, Bogle pressed on. He knew that the
index fund would give investors their best chance at capturing their fair
share of market returns over the long-term.

The First Index Investment Trust did well in its first decade, growing to
$600 million (which represented less than one half of 1% of mutual fund
assets). But competition was slow to encroach on their territory. In fact, the
second index fund wasn’t created until 1984, by Wells Fargo. The Stage-
coach Corporate Stock Fund came with a 4.5% sales load and an annual
expense ratio of 1%.20 Today, the fund has just $2 billion. I guess there is
something to Bogle’s saying “ideas are a dime a dozen, but implementation
is everything.”

Success found its way to index funds in the second decade after their
creation, when they went from $600 million to $91 billion. In the end,
Bogle was vindicated, and then some.

From 1976 to 2012, the Vanguard 500 returned 10.4%, compared
to the 9.2% return of the average large-cap blend funds. The 1.2%
difference is nearly identical to the one Bogle presented to his board
40 years earlier. That decades-long track record illustrates the consistent
returns that index funds can offer – their primary benefit over other types
of investments. Today, index funds represent around 30% of all assets
held in mutual funds.

Perhaps most remarkable of all, in 2016, the $289 billion net flows
into Vanguard exceeded the other 4,000 global fund providers in
Morningstar’s database, combined.21

Jack Bogle didn’t create the index fund until he was 47 years old. So if
you’ve yet to find a method of investing that you’re comfortable with, it’s
not too late! Maybe you’ve been going back and forth between picking
stocks, buying options, or timing the market, all with little to show for it.
That’s fine, you’re still on the path to discovery. I know all about it.

It took me around five years and nearly $20,000 in commissions to
realize that I was not destined to be the next Paul Tudor Jones. I was
too emotional to be a successful trader, which led me into the arms of
Bogle’s index funds. Not everybody can buy and hold an index fund – it
can be grueling and difficult, rife with drawdowns and potentially decades
with nothing to show for it. But warts and all, for me, this is the best
way. Not everybody comes to this conclusion and that’s okay. The impor-
tant part is finding a methodology that you are comfortable with. But a
methodology means something that is repeatable. It means having a pro-
cess. The stock market throws far too many curve balls for you to wing it.

With people living longer than ever, we need to expect and be prepared
to fund a long retirement. In order to do this, you, like Bogle, need to
find what works for you! Hopefully, after reading how a giant like Bogle
was dealt a few blows, you’ll realize that investing is a lifelong journey of
self-discovery. If you’re still on your journey, keep searching.

Notes
1. Credit Suisse, “Looking for Easy Games,” January 4, 2017.
2. Morningstar, “Recommendations for Fund Companies Not Named
Vanguard,” December 27, 2016.
3. John C. Bogle, “The Professor, the Student, and the Index Fund,”
johncbogle.com, September 4, 2011.
4. Vanguard, “Reflections on Wellington Fund’s 75th Birthday,” 2006.
5. Ibid.
6. Adam Smith, Supermoney, foreword by John C. Bogle (Hoboken, NJ:
Wiley, 2007).
7. John C. Bogle, The Clash of the Cultures (Hoboken, NJ: Wiley, 2012).
8. Institutional Investor, “The Whiz Kids Take Over,” January 1968.
9. Bogle, The Clash of the Cultures, 262.
10. Michael Regan, “Q&A with Jack Bogle: ‘We’re in the Middle of a Revo-
lution,’” Bloomberg.com, November 23, 2016.
11. John Brooks, The Go-Go Years (Hoboken, NJ: Wiley, 1999), 128.
12. Bogle, The Clash of the Cultures, 272.
13. Smith, Supermoney.
14. Ibid.
15. Bogle, The Clash of the Cultures, 272.
16. Smith.
17. Ibid.
18. Quoted in John C. Bogle, “Lightning Strikes,” Institutional Investor 40,
no. 5 (Special 40th Anniversary Issue, 2014): 42–59.
19. Bogle, The Clash of the Cultures, 278.
20. Ibid.
21. Ali Masarwah. “Indexing, Vanguard Drove Global Fund Flows,” Morn-
ingstar.com, February 4, 2017.

 

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