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Vanguard's Mr. Thrift vindicated

Critics said John C. Bogle's low-cost investment approach would only ensure ""guaranteed mediocrity.'' Last year, his mutual fund group took in more money than any other.

By HELEN HUNTLEY

© St. Petersburg Times, published March 14, 1999


LAKE BUENA VISTA -- When John C. Bogle breezes through airports, the 69-year-old superstar of mutual funds tackles the stairs two steps at a time.

"I'm not a kid anymore, but I stay moving," he said. "When you've got it, flaunt it."

A heart transplant three years ago put the bounce back in Bogle's step. After years of being unable to drive or climb stairs, he is making up for lost time.

But his health is just one reason the founder and senior chairman of Vanguard Group is feeling chipper. He also is enjoying the satisfaction of seeing Vanguard's low-cost investment approach trounce most of the competition. With stocks trading at record heights, Vanguard's Index 500 Fund is on track to become the largest mutual fund in the world sometime this year.

For more than two decades, Bogle has been a zealous evangelist for low-cost investing and an outspoken critic of the mutual fund industry for its failure to see the light. Competitors complained about his "holier than thou" attitude; one even gave him a clerical collar as a joke.

"You probably think I sound like Elmer Gantry or the apostle in that Robert Duvall movie," he said during a recent interview. "Sometimes I feel like that, but this is not a question of faith. This is a question of mathematics, and I don't think there's any refuting it."

John J. Brennan took the reins as Vanguard's chairman and chief executive three years ago, but Bogle still works overtime, corresponding with shareholders, giving pep talks to Vanguard employees and continuing his "missionary" work for low-cost investing. For the past year and a half he has been working on his second book, Common Sense on Mutual Funds, due out next month from publisher John Wiley.

Bogle's unconventional investment approach made Vanguard a pioneer when the company launched its first index fund 23 years ago. The concept was simple: Instead of trying to pick winning stocks, its manager would just buy the stocks in the Standard & Poor's 500 Index and hang on to them. By keeping trading to a minimum and costs low, Bogle was certain the fund would do better than most of its competitors.

Even Vanguard's own board members were not convinced it would work: The vote to launch the fund was 7-4, and skeptics labeled it "Bogle's Folly."

"When we started, we had 80 consecutive months of more money going out than coming in," Bogle said. "How things change."

Last year Vanguard brought in a record $49-billion, more than any other fund group. The company, based just outside Valley Forge, Pa., has $450-billion in assets, making it the second largest fund company after Fidelity.

The biggest draw: Vanguard's index funds, which track everything from small-cap stocks to short-term bonds. The flagship 500 Index Fund has crossed $79-billion in assets and appears likely to pass Fidelity Magellan this year.

It's not the big dollars alone that count with Bogle, whose friends call him "Jack." He says it was more fun when he came to work each day "knowing you had to do something or you might go out of business." But the dollars show investors are recognizing something dear to his heart: that indexing works.)

"When he started, nobody liked what he was doing," said Tampa money manager Steven Adler, who runs a small index fund, the ASM Index 30 Fund. "But he stayed with it, and today more than 20 percent of the new money is going into index funds. The institutions figured out, and now individual investors have figured out, it's very hard to beat the market."

When Vanguard introduced its first index fund, competitors poked fun at the idea of "guaranteed mediocrity." Fidelity chairman Edward C. Johnson III once told the Boston Globe that he did not expect his company to offer index funds. "I can't believe that the great mass of investors are going to be satisfied with just receiving average returns," he said.

Now many competitors have their own index funds, Fidelity included. Investors can choose from funds tracking 29 different indexes, according to Index Funds Online (http://www.indexfundsonline.com). At least 17 fund companies offer S&P 500 funds, including Fidelity, Schwab, Scudder, Invesco and T. Rowe Price, although Vanguard is still the only one to make indexing the core of its business.

As Bogle had predicted, lower costs have given index funds an advantage the average competitor simply has not been able to overcome.

"If you start half a mile down the road from everybody else, it's tough for them to catch you," said Gerald Perritt, Largo-based publisher of the "Mutual Fund Letter," a newsletter for mutual fund investors. "John Bogle revolutionized the mutual fund industry. He put this notion that costs are important directly on the table."

Bogle's obsession with costs dates back to 1951 when he wrote a senior thesis at Princeton University on how a mutual fund company ought to be run. The paper was good enough to land him a job at Wellington Management Co., manager of the Wellington Fund, where he worked his way up to chief executive.

But Wellington, which pursued a high-cost, aggressive trading strategy, lost half its assets in the bear market of 1973-74. Bogle had a falling out with his Wellington partners, and they fired him.

Rather than admit defeat, Bogle started the Vanguard Group and set out to steal Wellington Management's business. He convinced the independent directors of the Wellington Fund to turn its administrative duties over to Vanguard. The company was on its way. Bogle named his enterprise after the HMS Vanguard, flagship of the British fleet in a 1798 victory over Napoleon. But Bogle wasn't content running the Wellington Fund's financial and legal affairs. He wanted Vanguard to manage money, too -- and the birth of the index fund was the result. Wellington and other outside companies still actively manage money for Vanguard, but the heart of the company today is its stable of stock index funds and low-cost bond funds, all managed in-house without profit. The company is owned by its mutual funds, which in turn are owned by their shareholders -- a structure unique in the fund industry and the main reason Vanguard's costs are so low.

Bogle is a multimillionaire, he says, thanks to 47 years of regular investing. (He declines to be specific about how many millions.) If he had created a traditional mutual fund company and kept most of the ownership for himself, he might be a billionaire today. But he says the lost opportunity doesn't bother him.

"I don't know what one would do with a billion dollars," he said. "I don't particularly get joy out of spending money, and I don't think you can take it with you. It might be nice if I had my own jet to get me around, but I doubt that I'd be very comfortable. I'd be thinking about how much it's costing."

The cost-consciousness that pervades Vanguard's operations starts at the top with Bogle, who still saves paper clips ("only the big ones," he says) and watches his travel expenses.

Just how cheap can he be? Bogle describes his decision to skip lunch when he was in an Omaha hotel preparing to meet with Berkshire Hathaway chairman Warren Buffett:

"I thought I'd go down to the dining room and grab something, but I looked at the menu and an entre was $12.95," Bogle said. "I thought by the time I get an iced tea and leave a tip, it's going to cost $17, and what's the point of that?"

Instead, he walked down the street looking for alternatives to tide him over until dinner. He found a bagel shop where he bought a peanut butter bagel for 74 cents, then snagged a free Diet Coke from a table in the hotel lobby.

"Why wouldn't somebody do that?" he asked.

While there might be other fund executives willing to copy Bogle's lunch habits, so far no other fund companies have been willing to pinch pennies the way Vanguard does. The average annual cost for Vanguard's funds is 0.28 percent of assets, while the average cost industrywide is 1.25 percent.

"They're un-American," said Perritt, the Largo newsletter editor, only half joking. "The rest of us are in business to make a living."

While stock funds get most of the attention, Perritt says it is Vanguard's bond funds that benefit the most from the low cost structure.

"You just can't beat them," he said. "When you look at the returns from bond funds, they're 8 to 9 percent over a very long period of time. A 1 percent difference (in expenses) is 11 percent of your return. It's huge."

Bogle says he keeps nearly all his own investments in Vanguard funds, although he does own stock in two companies for which he serves as a director -- television broadcaster Chris-Craft Industries Inc. and paper company Mead Corp. He says his favorite funds are Vanguard Total Stock Market Index Fund, which tracks the Wilshire 5000 Index, and the group's tax-managed funds, which keep taxable distributions to shareholders at a minimum.

But concern about high stock prices has prompted Bogle to trim his stock investments recently, shifting some money into bonds.

"I think we live in a rather scary time from an investment standpoint," he said. "Most people are extraordinarily optimistic and optimism drives out fear. We've got a lot of hope out there now, not only that the world will behave properly but that it will continue to grow substantially. If the world doesn't work out perfectly, stocks are terribly high. I'd say stock are somewhat high even if it does. Yet the market goes its merry way."

Although he doesn't believe in moving money in and out of stocks based on your market outlook, Bogle said he decided it was time to be more cautious with the retirement savings plan that his wife, Eve, will inherit at his death. The Bogles live in Bryn Mawr, Pa., and he describes his wife as a "full-time grandmother" of 12.

They have six grown children, only one of whom followed him into the mutual fund business. Son John Jr., 39, was managing funds for Numeric Investors in Cambridge, Mass., until last month when he and the company founder parted ways.

Bogle says much of his wealth is going to charity. His favorites include the Philadelphia United Way, Princeton and Blair Academy, the New Jersey prep school he attended.

Age doesn't appear to have dimmed Bogle's fervor.

"I'd love to find someone who wants to debate, but I haven't found anybody yet," he said. "I need to do what the politicians do, go around and have an empty chair next to me. Where is the other side of all these arguments that I put out? How about one that says "spending the shareholders' money on marketing improves returns?' It's just not justifiable, but that's what's going on in the industry."

When he was invited to speak at the Florida Money Show at Walt Disney World last month, Bogle jumped at the opportunity to criticize his fellow speakers. Bogle called the money managers' and newsletter editors' wealth-building strategies financial witchcraft.

"This show is telling you things that can't be done," he said. "Investment success lies in simplicity as basic as the virtues of thrift, independence of thought, financial discipline, realistic expectations and common sense."

Although he has no plans to retire, Bogle says there are no particular goals on his agenda.

"I don't think in those kind of terms," he said. "My idea is to just get through the day the best you can, get a few useful things done and then do it again tomorrow."

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