Bogleheads on Investing with Eric Balchunas – Episode 44

Eric Balchunas joins us for Episode 44 in our Bogleheads on Investing Podcast series.

Eric is the Senior ETF Analyst at Bloomberg. He writes research reports, articles, and feature stories about ETFs for the Bloomberg terminal and Bloomberg.com. In this episode, we discuss his new book is The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions.

You can discuss this podcast on the Bogleheads forum at the topic Bogleheads podcast guest, Eric Balchunas, on his new book, “The Bogle Effect”.

To join the conversation in the forum, click here.

Rick Ferri: Welcome everyone to Bogleheads on Investing, podcast episode 44. Today our special guest is Eric Balchunas, senior ETF analyst at Bloomberg Intelligence. Eric recently wrote a book, “The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions”.

Hi everyone, my name is Rick Ferry, and I’m the host of Bogleheads on Investing. This episode, as with all episodes, is brought to you by the John C Bogle Center for Financial Literacy, a 501(c)3 nonprofit organization. Please visit boglecenter.net Your tax-deductible dollars are greatly appreciated.

Today our special guest is Eric Balchunas, senior ETF analyst for Bloomberg Intelligence. Eric was my guest on episode number 15 where we talked about his former book, “The Institutional ETF Toolbox”. This time we’re talking about a new book, “The Bogle Effect.” And what exactly is the Bogle effect? It’s not just Jack Bogle’s life; it’s not just Vanguard; but it’s the influence that he had on an entire industry, in fact the entire world. You can pre-order today, and it will be published on April 26th. So with no further ado, let me introduce Eric Balchunas. Welcome again to the Bogleheads on Investing podcast, Eric.

Eric Balchunas: Oh, it’s great to be here Rick. I’m a big fan of the podcast and all the work you do.

Rick Ferri: Well last time you were here was episode number 15. So it was a couple of years ago. Back then we were talking about your previous book, The Institutional ETF Handbook, and this time we’re going to be talking about your new book, The Bogle Effect: How Jack Bogle and Vanguard turned Wall Street Inside Out and Saved Investors Trillions.

I’d have to say you’ve done a wonderful job with this book. But before we jump into that, I mean your job at Bloomberg is the senior ETF analyst and as we both know Jack Bogle thought that ETFs were a product of the devil. So what is an ETF analyst doing writing a book about Jack Bogle?

Eric Balchunas: Well it’s a good question Rick because Bogle was very animated and colorful in his critique of ETFs over the years. I know because I went to interview him multiple times and challenged him on this and asked him questions about ETFs. But my first time really sitting down and interviewing him came in about 2013-ish and I was writing a book on ETFs, which you mentioned, and I wanted to get his take on them.

Some of the trends going on, like smart beta, I wanted to include him in the book. I write my books like semi-documentaries, and I like a lot of voices in there to give the topics more angles and color. And I thought Bogle on ETFs would be a way to get the green vegetables. You know, so I don’t get too carried away with ETFs. Let’s get, let’s get the grandfather puritan voice in here to maybe give the other side of the ETF story. And he was critical and I put some of his criticisms in my first book. But I kept pushing back, and at the end of the day I think his problem was trading and marketing. That said, there’s plenty of ETFs that aren’t really full of gimmicky marketing, and that are not traded that much, and so he did admit that and acknowledged that over the years. But that was ultimately his issue and I have a chapter in the book called Bogle and ETFs – It’s Complicated.

One of the reasons I wrote this book as an ETF analyst is that I was shocked, and it always stuck with me when I interviewed Steve Bloom, who created the first ETF with Nate Most at the American Stock Exchange. He told me the story of going to Bogle’s office talking to him about ETFs. Bogle giving him some advice but saying you’re never going to use the Vanguard fund for this. But he was nice and one thing he said was, “Well, we priced the first ETF SPY at 20 basis points of a fee.”

Rick Ferri: And just for clarification, SPY is…

Eric Balchunas: The Spyder S&P 500 ETF. The first ETF launched in the US. It’s the biggest to this day. It’s basically king of the ETF world and it was the first one launched and it had a price point of 20 basis points and why did they do that? He said, “Because Vanguard’s 500 index mutual fund was 20 basis points at the time.” Which is pretty cheap, especially in the ‘90s. This is absolutely major and it really dawned on me that the ETF industry would be a tiny fraction of itself had Vanguard and the mutual ownership structure not gotten to 20 basis points at that point. These are guys from the American Stock Exchange, they weren’t exactly like retail people. We know Wall Street, they probably would have priced it at 80 or 90 because that’s just what you can get away with back then until Vanguard hit the scene. And that is huge because if you start to think about that you realize that the ETF industry is almost largely built off of retail and advisors at this point and there’s no way they’re buying an ETF you know at 80-90 basis points– maybe a couple, maybe at the fringes it would have some assets– but I just think that was an interesting link and something where I thought, “Wow, Bogle had this profound effect on something that he hated.” And then as I researched this book I realized over and over this was the case.

Rick Ferri: I get what you’re saying exactly, and I really love the title of the book, The Bogle Effect, because what you just described was part of the Bogle effect, which was that even though Vanguard didn’t create ETFs and Jack hated ETFs that he had such a profound influence right at the beginning in the ETF marketplace and this perpetuates through many many things that we’re going to talk about here on this podcast. It’s not just index investing, it’s the whole entire industry and not only in the US but now around the world. And so the Bogle effect is just growing in many different directions. So I think it’s a great title. The book, which I found fascinating– of course I’m a Boglehead and I read all this stuff kind of a geek if you will– and thanks for mentioning me a few times in the book as well, I appreciate that.

You’ve done a great job describing who Jack Bogle really was. People used to call him Saint Jack, right. I mean he was like – as soon as he had this idea about indexing you know his world changed and he was all about indexing and so forth but that’s not really true, okay? And I think that you brought that out of the book and I think it’s interesting, so this is sort of the true story of Jack Bogle and Vanguard and the rise of Bogleism if you will. You know Bogle was an investor activist most of the time during his life, although not all of the time, and so let’s start with Jack Bogle, the beginning, and the fact is he was an active investor.

Eric Balchunas: Yeah. So he ran Wellington, which was a balanced fund. It was the big Wellington Fund, it was balanced and it was active, and I think you know had some. I’ll go into the… But had a crisis not emerged, that Wellington, I believe he would have stayed there. He was happy there but fate intervened, and what was interesting is he had this balanced fund and everybody can identify with it because it’s just like this era.

The last 10 years, you know how growth stocks have gone wild. They’ve sold off a little this year but for the last 10 years, if you’re a value investor or doing anything conservative, you probably had a tough time in the past decade. And so it was a similar situation where there were funds like ARKK just going wild and basically capturing and riding this wave, and his Wellington fund was conservative and it wasn’t going well. They were losing customers and assets and clients and his boss Walter Morgan said, “Okay, look you’re– I’m going to hand the firm over to you at age 35. I need you to fix it.”

So he said, ”Look I was selling bagels and everybody wanted doughnuts across the street, so I thought we should start selling doughnuts.” And it’s a great metaphor because doughnuts are sweet and just like, you know, high-performing funds, or in a similar way sweet but maybe not good for you. And so he looked to try to team up with an equity company that was good at equities and he went through like four or five people, and I actually think he brought this up on your podcast. I think he was on the first one, I’m sure, right?

Rick Ferri: Yeah he was. He was my first guest.

Eric Balchunas: He said he went to Capital Group. They didn’t want to, they weren’t interested. He goes to Franklin. They weren’t interested. And ultimately he lands at Thorndike which had this Ivest Fund and it was a real popular fund. And so it wasn’t his first choice. These were like his fourth or fifth choice and they were really polar opposites. And for a while it worked. It was like they had gotten chocolate to match with the peanut butter. It seemed good but then the market basically dropped. After the ‘60s were over, in the early ‘70s it felt like I believe it was 35 in two years and basically they had changed the Wellington fund to be almost all equities and so the Wellington fund went down as much as the market.

Rick Ferri: Just rewinding the story a little bit. So during this period of time, the go-go years of the late 1960s, you had companies like Xerox and Polaroid, IBM, Avon, Extron. I remember all the tron stocks actually. Yeah, these are the Facebooks and the, you know the Googles of the day if you will.

Eric Balchunas: These were the Teslas of their day.

Rick Ferri: And they were not in it and at Wellington and so they were trailing yeah far behind the rest of the market and losing assets. but then when they brought in these other managers, and they did load up the Wellington with these stocks, unfortunately you got, if you were a Wellington investor, you not only did not keep up with the market during the ‘60s, but now you had all these other stocks. It’s like buying ARKK at the peak and then boom, down it comes and you lost 40 percent when these stocks drop. So you didn’t get any of the upside, you got very little of the upside,and you got all the down. He must have been in some really deep trouble.

Eric Balchunas: Yeah I imagine he felt he betrayed his boss, his mentor, and himself. And he was pissed off and apparently he was no picnic to deal with either. I can’t say – he in his books, he sort of writes himself as the victim and I guess there’s some of that, although he admits “I made a mistake hiring these guys or merging with them” and he gave them effective operating control of the board or voting control of the board. He gave away too much in the deal. Anyway, they had a voting control of the board and they were not into him and they fired him. But then he realized that he was actually chairman of the funds themselves.

Rick Ferri: Yeah, and to explain that. Explain that a little bit.

Eric Balchunas: Yeah, it’s a quirk in the system. Like Wellington’s the investment advisor and the funds have their — are like shell companies themselves– so they have, they hire out an administrator, an advisor, and so there’s the board of the company Wellington and there’s the board of each fund. And so Jack was chairman of the funds and so he had some power. They didn’t realize this and so he decided to basically dig in and as chairman of the funds sort of fight to keep control of something versus Wellington the company and it was actually a pretty brilliant move. He’s basically starting a young family at this point, the pressure’s on so he had a lot going on but he’s a fighter. I mean this guy, he’s not going to like just go away.

Rick Ferri: You tell the story in the book how he used to play squash and he had a heart condition and so he used to bring a defibrillator to the court and he would tell his opponent that if he passed out you know run and get the defibrillator and you know shock him back which I assume he would continue to play at that point. I mean that’s the kind of person he was.

Eric Balchunas: Yeah. I mean this guy was hardcore and especially the issue with his heart. He was supposed to die like 10 times. He was told he wasn’t going to live past 35-40. I think being that close to death all the time probably gave him a jolt of life and a fight that maybe you know other people don’t have and it may be a sense of purpose.

So back to the bifurcation period you have Bogle on one side and the Thorndike guys on the other. Bogle and the board and they all say look we have a mess on our hands. Bogle, why don’t you come up with a way to basically come up with a solution in which your funds can live in harmony with Wellington the company. So Bogle and his two assistants, Janet Wardowski in particular. It seems like a scene from Jerry Maguire¹. They crammed and wrote this 250-page report with a couple solutions. They needed some kind of a solution where they could just work together without– you know, even though they hated each other– and so the board of the funds which actually had, I think, three people from the Thorndike crew and I think seven or eight from the Philadelphia Wellington side that were more friendly to Jack. But still there were three on there from the Thorndike side so they needed something too, and they, the board, wanted it to be unanimous.

So basically Jack had to propose something that would make it seem like he wasn’t trying to make out like a bandit or impose too much control and also mess with Wellington or Thorndyke’s desire to run money. So the solution was you become a back office administrator for the funds and will mutualize. Therefore it doesn’t look like I’m in this first for money or anything. And so that’s sort of how he was able to get the unanimous approval of the board and keep his job. And then he took about 25 -30 people with him and that he decided to call that company Vanguard.

Rick Ferri: And just to clarify. You say back office administration. I mean what does that cover?

Eric Balchunas: Basically all the funds have holdings and you have to calculate what the value is every day. Basically all the operational details that go into sending out, you know the NAV [Net Asset Value], the numbers, keeping track of it. Probably working with the custodian. Basically all the not fun stuff. Wellington, the company that Thorndyke was now running, they would still be the investment advisor. So they would run the money and do the investments, which is what they liked anyway. So the back office is an unsung job. It’s necessary for any fund to operate but I mean I think most people find accounting and administrative tasks pretty boring.

Rick Ferri: And so they went ahead and went with that. So Vanguard got started. It was kind of a non-event if you will. The media didn’t really even pick it up. It was not a big deal. It was just, okay Wellington is just going to offload this back office administrative stuff to this new entity that they formed. That’s not a profit center, if you will, it’s just, you know at cost, and called Vanguard. I mean probably didn’t even make the last page of the Wall Street Journal at the time.

Eric Balchunas: That’s right. And that was a way to sell it to the Thorndike side because they thought, ”Okay, fine. You do the back office, we’ll run money. That’s what we’re good at anyway. That’s what we want to do and we can now move forward together even though we’re not friends.” And that was the deal they made.

Rick Ferri: But then something happened, right? How did they end up starting the S&P 500 fund if they can’t run money?

Eric Balchunas: Yeah again, and the serendipity in that story is ridiculous, right. Like the amount of things that had to happen just for Vanguard the mutual to be born were crazy. Then for Vanguard to launch an index fund, it was also a crazy serendipitous situation because he read an article by Paul Samuelson right after he started Vanguard. So good timing, and Paul Samuelson was saying someone should just set up an index fund just so we can benchmark all these gunslinging active managers and see what they’re really worth. Also Burton Malkiel, who was talking about if there isn’t an S&P 500 index fund there should be, and that was quoted in his Random Walk Down Wall Street book which was published in 1973. And there were some other people as well, like Charles Ellis and other folks who were alluding to the fact that they should be index funds.

And Bogle’s just like, “you know what, I’ll do it, and I won’t be running money. We can actually try to sell it to our board by saying this isn’t running money because it’s passive.” So he actually got it through. As he says later in an interview, they actually bought it because – even I think he thought, “Well this is a real, this is a big technicality I’m trying to drive a truck through.” But he got it through and that was a way for him to sort of follow. He liked the idea. He saw the returns were pretty good versus the group of active funds. The data was there. Paul Samuelson buying in helped him a lot because he has academic credentials, like “I worked for Kennedy.” And so Bogle was able to get that idea through the board. And then they filed for the first– I think it was called the First Investment Trust– that wasn’t Vanguard at first. And then that was in I believe ‘75.

Rick Ferri: In fact there were attempts at doing index funds in the early 70s before Vanguard through Wells Fargo and Batterymarch Financial and American National Bank in Chicago. So there were other attempts at this. This is, if you will, not Jack Bogle’s idea, correct?

Eric Balchunas: No I don’t think it was and I think anybody would debate that and in the book I have a small section called the Origins of Indexing and I go back to MIT, Chicago, John McQuown, who worked at Wells Fargo it was– it kind of reminded me of the PC and Steve Jobs. Steve Jobs did not invent the PC or personal computing– but in every business there’s usually somebody who’s able to bring it to the masses, and that’s a whole different ball game.

The other thing is even though people could have an ideal idea of this and think about it and buying the S&P, it’s a different story when you have to sell it to your big boss at the bank or whatever. “Well I’m not going to sell a fund for three basis points, or whatever, 20.” They want to make money. And so to me, again this brought me back to why I really focused on Bogle, because none of this really happens to any extent like it has happened without the mutual structure. And that structure is why indexing is popular. It was because it’s cheap. The index just happened to be the perfect vehicle for the mutual ownership structure and an idea whose time was ready. So Bogle was in the right place, right time. And the index fund was honestly– I actually have this statement in the book– which is that indexing and index funds needed Vanguard more than Vanguard needed index funds, if that makes any sense.

Rick Ferri: Yeah it was the structure of Vanguard and the non-profit nature of it which allowed this to eventually grow. Although it didn’t at first, right? I mean the mistake that was made was they tried to raise their initial capital through the brokerage industry and that did not go well.

Eric Balchunas: No. There were stories about them going out and the pitch they used was well, what if I could tell you could go out in the golf course and shoot par, would you lock into par. And they said that played okay. But like, basically they wouldn’t pay brokers. That was problem number one. And number two is it really is a hard concept to understand. It’s counterintuitive to think that just buying all the stocks in market cap, in a market cap weight, would actually be good. So I spend a good chunk of the chapter on the index fund, not essentially on why indexing makes sense or doesn’t, but just how Bogle sold it. And he had to sell it outside of the system which makes it even harder. It’s like making a movie and no cable channel will carry you. No movie theater will carry you. You basically have to sell it outside of the entire system and it took a long time because of that. And it took a long time because of the counterintuitive nature of it. So he was very creative. I think some of the ways he did it was to show the growth of ten thousand dollars if you get five percent versus seven percent.

Rick Ferri: But he had to take that direct to the public. And so the idea of going through the brokerage industry to raise capital like they were– according to Jack Bogle they were trying to raise 150 million– that’s what he said in my interview, before they launched this fund, which ultimately did launch in 1976 but they ended up only raising through the brokerage industry 11 million dollars. In fact, in my interview with Jack, you should not even launch the fund if all you have is 11 million. I mean it should never have existed.

Eric Balchunas: Yeah. You know it gives the story some drama because here you have this flop. Everybody knows the big deal today but it flopped. And so you have to put yourself in the time and place and wonder would you have kept it going. Plus keep in mind they launched it when Wellington– again those funds were within an 80-month streak of outflows. It was just a brutal time. But they hung in there. I think he just believed in the idea. It took Vanguard 25 years to even get 10 per cent market share. That is a long time and if you look at a chart of all the people who ran Vanguard, Jack’s time is the line of assets is all the way at the bottom for his whole tenure. It only starts to go up after he passed it off, but that groundwork was so major and the blood sweat and tears of hanging in there. And if you read his book Character Counts— it’s all his speeches from like speech in 81, 82– it’s like the Christmas party speeches, and each one is like, ”Hey, we got to three billion. Can you believe it?” And every billion is like this huge victory. Now they’ve taken a billion, over a billion a day. It’s wild.

Rick Ferri: Interesting you say that because the Vanguard S&P 500 was– going back to the story of the Vanguard S&P 500, the First Investor Trust–being launched in 1976 and with only 11 million. They couldn’t even buy 500 stocks; they could only buy about 275 stocks. And another thing was, and I had asked him this on my podcast, and it really was mind-blowing, is that the first fund manager, the one who did the trading in that account, was one of his assistants who was run part-time–this is his quote –by a young woman whose full-time job was to work with her husband at her husband’s furniture store in Wilmington, Delaware. I mean you can’t make this stuff up.

Eric Balchunas: Yeah. I remember my second time I interviewed Jack, and when he told me that story I almost fell over. I was, like, really? It speaks to the sort of small business upstart kind of atmosphere that was happening at the time and, how again, big ideas are sometimes seem so not a big idea at the time. You make a good point by not having all the stocks and having a high fee. I think it launched in the like 45-50 basis points. The tracking was pretty bad. I think it might have missed the index by 60- 70 basis points, which today would be like a horror show.

If you look at a chart over time the fee came down and the tracking got better. They brought in Gus Sauter to really sort of bring his math skills in and his ability to trade and he really, really tightened up the tracking and so, again today, it’s not just that like the total market fund is three basis points but it’s actually zero because they’re able to use securities lending and some passive management acumen to make up a couple bips and that is, again, that’s a modern miracle that you can get free exposure you know even beyond the fee.

It’s funny. When they first tried to pass the idea of an index fund to the board they couldn’t call the person running it a portfolio manager so they called James Wardowski a portfolio administrator.

Rick Ferri: They didn’t have any money in the fund. They couldn’t buy all 500 stocks until I believe it was 1977, when Wellington merged one of their funds, one of their large cap funds, into the S&P 500 and which brought the assets up enough to be able to buy all 500 stocks. And then this was now the true replication of the S&P 500, and they also fired all the brokers. They went to a no-load direct to the consumer product with this fund, and even then though it took years, I think, till they first got a billion dollars, and it was something like at least 10 more years before that fund actually took in a billion dollars in assets.

Eric Balchunas: Yeah the amount of time it took was another thing that drew me to the story. The other thing that I found interesting was not only everything you just said, but as it did get a little traction they would turn down money regularly.

I was shocked by that. Gus Sauter told me that on multiple occasions they’d have a big institution wanting to come in for like a month but they were like “get out of here we don’t want your money.” And turning down money is something that a private equity manager would do, or perhaps you’re in an area, the market that isn’t liquid like small caps. But for a young large cap fund to turn down money is really shocking and I think it speaks to the “walk the walk.” This guy was all in and was able to sort of really discipline himself in a way that’s so difficult in this industry. People lose their minds. They want money. They want to get rich and I get it. It’s what draws people to Wall Street and this guy just seemed to not have any of that bug or any of those sort of tendencies, which enabled him, I think, to walk this really straight line even if it meant slowing their growth rate. He just seemed to be somebody who almost was miscast in the whole industry.

There’s so many stories like that which are just the opposite of what the natural tendency is for people in asset management to do. And that was, that’s I think what it took to last all that time. I think also the pain of working with the Thorndike guys and the idea of selling your soul during a bull market only to lose out. I think that lesson allowed him to walk that straight line through many cycles and through many opportunities where he could have taken a faster route to higher assets. It was like purposely taking the slower more prudent route and that core of investors that is long term, and his absolute protection of them, is really in my opinion why today when there’s a sell-off you still see money going into Vanguard funds. People are like, how come Vanguard can take in all this money when everything, everybody else, is losing money because the market’s down? And I’m like you have to go to the core and how it was built and how people found it and the trust gained and that’s why I wanted to tell the story. It explained so much today.

Rick Ferri: I want to circle back a minute to the mid 1970’s when the first index fund was formed. There was this whole academia thing going on called the efficient market hypothesis. And people sometimes link indexing to the efficient market hypothesis, saying well you can’t beat the market, the market is the most efficient way to invest. That’s what Bogle believed and that’s why index funds were formed. But none of that is true. I mean he didn’t even know that–with the efficient market hypothesis– was going on, even what it was, until long after he created the first index fund. And this whole idea of you can’t beat the market because the markets are efficient. I mean Jack Bogle never said that. He was not anti-active.

Eric Balchunas: No,not at all. Vanguard is the third biggest active manager today. Bogle took almost more pride in the Wellington Fund, in his books, than any other fund and that’s active. He loved the Primecap Fund. I will say that the way he talks about why those funds are successful, it reminds me of the book Moneyball and sabermetrics. Whereas most active managers are like, I found this perfect formula, I found this premium and they got all this – you know and they maybe they’re highly educated and they are able to sort of sell that.

Bogle basically gave credit for why his active funds outperform because of the costs. He was able to keep eliminating basis points from their costs. He also had in some cases multiple managers. He wanted them to be more conservative, not trade a lot, and I think those– I call them Bogle metrics– those data points he attributed to why his active funds were so good. So he was okay with active but he thought that cost really brought down most of the managers, and in his book he says they’re all highly, you know a lot of them are highly educated, they’re nice, they’re honorable people, but they have math working against them, they have cost working against them.

And the efficient market hypothesis – I put in here that I get it and I think you could argue that like, okay there’s all these people covering Amazon stock; what could you possibly know? So for some big stocks I think there it does pass the sniff test. Of course Amazon is properly priced because there’s all this information everybody knows, everything but the sniff test, in a holistic sense doesn’t work. People probably would argue Tesla’s overvalued. It doesn’t seem efficient right now. Meme stocks, the market never seems perfectly efficient.

What Bogle came up with he riffed off of that and said I’m going to do something called the cost matters hypothesis and he wrote a Journal of Indexing article on it that does pass the sniff test. I think when people think about how much cost eats up, especially in the compounding way and they see charts of dollars and cents, I think that passes their sniff test. So I think Bogle was actually good, smart to avoid attaching himself with EMH and way better to focus on the cost which are– it’s not as sexy, it’s not as interesting, probably not going to get any like Nobel Prizes, but it really is– that’s where the trillions of savings has come from. It’s just the costs and that’s what he honed in on. And that was probably his number one thing overall, beyond indexing, even beyond trading, I think – and his son told me this, he said, “He was preaching low cost from the day I was born until the day he died.”

Rick Ferri: Vanguard was able to launch the S&P 500 because it wasn’t managed, they were just administering it. But when they did get permission to manage money some of the first funds that they launched were actively managed funds. They experimented with quant funds and they experimented with thematic funds and they experimented with style funds, correct?, and value. They would have the first value and growth funds. I mean this was not an indexing shop per se.

Eric Balchunas: Yeah this is one of the most fascinating things about Bogle, he spearheaded all of these things. He innovated all over the place. Those growth/value funds were innovative at the time. He had a quantitative fund in ‘87 that was, that sounds normal today, but it was not normal back then. Bond funds, he innovated there, international and even themes. Vanguard did have a couple theme funds.

What I found interesting is he would later in life come to trash all of it. He would trash things he innovated and launched over and over and over and I think over his life he just came to the conclusion that if you just can’t do better than buying the total market– that was his true love, I think– the total market even beyond the S&P. Buy the total market and just wait 50 years.

And I think anything outside of that he came to just say it’s just not worth it, it’s going to mess you up. It’s not necessary. And so I have a big theme in my book where I talk about this concept of addition by subtraction. And to me that is, really – that was almost the name of the book – because if you took Bogle’s life work I think it was taking this industry and just subtracting and subtracting and subtracting all the stuff you don’t need to you’re left with basically frictionless exposure. That’s the most efficient way to grow wealth over 40 -50 years. And for him that was the total market fund. Once you block into that you start to look at your past innovations and funds and you’re like why did I even launch this?

And so there was a lot of conflict at the end especially between Bogle trashing stuff at Vanguard that was actually doing quite well and taking in money. It was really, it’s kind of weird.

Rick Ferri: Studying Bogle and listening to him over 25 years and kind of dedicating my professional life towards that idea, I came to this four-step process that people go through. And the first step is called darkness, where you know you don’t know what’s going on. You’re trying to beat the market, and I mean you’re out chasing dreams if you will, and that’s darkness. And then you have enlightenment. And enlightenment is when you discover indexing and for Jack Bogle that happened in 1975 and they launched the first fund in 1976. He discovered the basic concept of indexing as a better solution: low fee, this is the way to do it.

But then you get into the next phase which is complexity and as I look at John Bogle’s life and Vanguard and what they did they took indexing to a different level, with many of these quant funds, sort of a type of an index fund if you will because all they were doing was eliminating what they thought were the high cost stocks in one of their quant funds, and it’s complexity. You take something that’s very simple and you just make it more complex. You know value investing, growth investing, factor investing, all of this.

And then finally, if you’ve done that enough, you get to the last stage which is simplicity. And what you just described, what I noticed in watching Jack Bogle’s evolution over the 35-year period – and my own evolution in this industry – was you do eventually get to simplicity. Total stock market is the place to be; total bond market; total international. This is all you need, and once you get to that phase you’re at the fourth and final nirvana stage if you will, and that’s what I learned from Bogle in at least his final years. It finally occurred to me that this is what he was doing. In fact, by the time Jack Bogle retired in 1996 he had the four funds if you will that were necessary for this. He had developed a total stock market index fund; he had developed a total international stock index fund; he had developed a total bond market index fund; and then he had another one for real estate. And I throw that in because real estate is a big part of the economy but not a very big part of the stock market. And so we had the essentials to do simple investing using just a few three fund or perhaps four fund portfolio.

Eric Balchunas: A lot of people I interviewed are fans of international and he wasn’t. He would actually say almost like half of the stuff you just named you don’t need. Again he actually started to cut away stuff that would, I think, traditionally be looked at as a main core holding. For most people international is probably the biggest area.

I found three things that he he thought that almost everybody who loved and disagreed with ETFs, international, and the idea that the asset management industry will ultimately all go or mutualize. Almost everybody I spoke with basically said I love him but I disagree with him on those issues. But you know you could, you have to take them all seriously and at least consider them.

And I think–you know I talked to Dan Egan of Betterment about the international – I think he put it best when he said, “Well, Rome fell.” And that, you can’t argue with that, and I think that’s one area where I kind of agree with Dan and not Bogle. l think international is good to own just in case for diversification purposes. But Bogle would probably argue well, you know 40% of US stocks get the revenue from overseas, therefore you’re already exposed. But anyway that’s again he– if simplification is those four things you named he’s beyond nirvana I guess because he got it down to just basically the total market and you know I think he did own some bonds on the side, like some tr– . I think he had some munis and stuff for tax purposes though. But beyond that, that was mainly – and that once he locked into that utter, utter simplicity of like one holding, it was just hard for him, you know, he can’t, like it’s not Bogle’s nature to not speak his mind. So that had him again at the end of his career kind of bashing and dumping on a lot of stuff that was taking in money at Vanguard. So I used to have this chart back in the day when I would go around to presentations and I’m like “Vanguard is so in the zone right now that they’re taking in cash and stuff that Bogle trashes regularly – smart beta, international” and I’m like that’s how powerful Vanguard has gotten, is that the founder is dumping on these areas and they’re crushing.

Rick Ferri: So let’s get into the Bogle effect. Okay. So we’ve talked just about Vanguard and what Vanguard did and how they grew and the different things that Jack Bogle tried and ultimately getting to, you know, the total market portfolios. But it’s just not Vanguard. I mean the Bogle effect is throughout the entire industry. I would say throughout much of the economy and globally, this effect that he created through low fee or Cost Matters Hypothesis just grabbed hold. You know I wrote a book about ETFs back a few years ago and the back bottom line is it all has Bogle in it, the whole ETF industry has Bogle in it – even though he hated ETFs.

Eric Balchunas: Yeah so this was fascinating and I remember when Vanguard cut their commissions on their trading platform maybe five years ago they had commission free ETFs.They were one, they were really the first major one to go to commission free trading ETFs. Everybody followed and it was at that point I said, “Wait, Vanguard is actually leading in that.” And then I really started to unpack where their impact is coming from. So you have the trading platforms largely followed Vanguard going commission free. Then you’ve got other people launching index funds and ETFs at the same price points as Vanguard funds because Vanguard has 50% of the passive market share but the other 50% are people who basically copied them and a lot of people in the book would say something like they did it kicking and screaming. Vanguard did because they wanted to and that mattered to them but they all acknowledged that Vanguard was probably the reason those other firms came in at those low price points.

And then you look at something like the advisor world and behavior. And I know this is a great topic you love but I would also argue that the Bogle effect is huge in behavior not just because Bogle railed against trading – we know the trading was right up there on his like deadly sins – but that the index fund gave people something worth holding. A cheap index fund was such an innovation and such a, as you call it, like the value proposition was so high and people who lock into an index fund I think if you ask them they would say “well even if the market’s down what am I going to do, jump on some fund that might have had a good year. Uh uh, I’m in a good spot” that makes behavior so much easier. So I know people preach behavior and they give credit to some of these studies, but honestly behavior’s gotten way easier because of the cheap index fund.

So that tool has really allowed for this whole birth of this new generation of advisors who are very behaviorally focused and it’s helped their clients save and build their wealth over the years. There’s been a lot of sell-offs over the past 12 years and if you basically dumped everything you have lost out on a lot of future gains. So behavior is something I think Vanguard had a role in two parts, just the preaching of don’t trade and, it’s the idea that you now have something worth holding and you know I think there’s a resignation, a positive resignation by a lot of people who own the cheap index fund, that “I’m done; I’m just not going to run around trying to find something better.” And that’s why you see them taking flows even during sell-offs.

Rick Ferri: Well, it’s interesting because I’ve been an advisor for almost 35 years now and so I’ve lived through this evolution and the advisors didn’t want to do the indexing thing at first back in the 1990s when I converted over to indexing. They didn’t. They didn’t want to do it. It was, you know, they were the masters, if you will. They would take these mutual funds and mix them and match them and try to outperform the market, and find the active managers that were going to outperform and so forth. But as they began to see flows going out and as more and more studies were published showing that indexing was in fact outperforming, they finally came into it.

And then you had the evolution of ETFs which made it easier to trade these index funds. So you didn’t – it was hard being at, like say, a Charles Schwab or some place and trying to trade Vanguard index funds because sometimes they didn’t allow you to trade certain class shares and there were high commissions to buy them. So when ETFs came along, it just, for advisors who weren’t custodying at Vanguard, it just made indexing so much easier. And even the brokerage industry– now when I was a broker, where I started out you could, the only thing I could buy was SPY, the S&P 500 and MDY, the S&P 400 mid cap– and that was in the, let’s say 1996-1997 when I started using those. That was it. That was the only thing that was available.

But by the early 2000’s you had much more variety of ETFs that advisors could use both in the brokerage industry and independent advisors. And I think this then helped them move their business models more to a core and satellite. They weren’t ready to give up on active management just yet. They went to a core indexing and then satellite of, okay now we’re going to pick a few areas where we think we’re going to outperform. That didn’t really work but that’s where the first phase was for the advisors.

Eric Balchunas: It’s also interesting and I explore this a little. I have your story and some other people’s stories in there in terms of the other side of the mountain as Michael Kitces puts it in the ‘80s and ‘90s. I think advisors deserve a lot of credit in really helping to build Vanguard because once they went from the I’m getting paid by the mutual fund to I’m going to get a percentage of assets, all of a sudden they’re now shoulder to shoulder with the client and they’re going to obviously pick things they think are good and that are cheap and will benefit them too because now they’re going to eat, you know, draw from that same pool of money. And that really was major. If you were to chart the growth of Vanguard’s assets and that move to the fee-based fiduciary advisor, I think there’s a strong correlation there. And the amount of money and it’s – it’s growing, certainly has great stats showing that, I believe 71 percent of the assets now in the brokerage advisor worlds are fee based fiduciary type assets. But it was interesting and I tried to see if maybe Bogle, by actually building Vanguard and putting Vanguard on the other side of the mountain where most brokers couldn’t get to it unless they left where they were. Remember you’re outside of the system so you’ve got to get people to leave the system.

Rick Ferri: Right, that’s what he wanted to do. That’s exactly what he wanted. That’s correct.

Eric Balchunas: And they did and I tried– I asked a few people whether Bogle should get credit for actually getting people to leave the system and become RIAs [Registered Investment Advisors]– and you know some people were like definitely, and some people were like no there’s all these other things going on. And I try to be nuanced, but I have to think that the idea of not being able to get this amazing vehicle for your clients where you were, would it might be one of the reasons you were inspired to leave. Maybe also the weighing on the conscience that I’m putting my clients in stuff that I would never invest in, and, you know, maybe over time that might weigh on them, but I try to think, let’s say there was no index fund, cheap index fund or something on the other side of the mountain, would brokers have left in droves and become RIAs? And I don’t know. I’d ask you that.

Rick Ferri: No, personally I probably would have become an airline pilot because I was a pilot in the military and I really just couldn’t stand the brokerage industry anymore. Once I learned about– well let me see, if the indexing didn’t exist– I probably wouldn’t be in the investment industry anymore because I was so disgusted with what was passing for investment advice in the brokerage world that I was ready to leave it anyway. But then I discovered Jack Bogle and discovered indexing and realized that if I left and started my own company that I could have access to all these things for my clients. And yeah, that was the reason I left.

Then I also, I think, helped start driving down advisor costs because I–as soon as I left– I realized, well advisors were charging too much money for this too. So I started a low fee advisory company back then, but yeah and I completely agree with you. I think a lot of advisors left the brokerage industry so that they could put their clients–they’re being fiduciaries– and put their clients into the things that they thought that their clients would benefit from. Then indexing was one of them and ETFs were another one. You know I told Jack this before he died. I said, “You know, I know you don’t like ETFs but I think that there’s nothing that has happened in the last 25 years has advanced your beliefs more than ETFs have.” And he goes, “Yeah.” You know he didn’t want to believe that but I think it’s true don’t you?

Eric Balchunas: Yes, ETFs have done a lot to get people low cost and indexing and not all ETFs trade a lot. The Vanguard ETFs in particular are basically bought and held. I mean they’re not really trading tools and he did acknowledge that. I also had a revelation in the book that I did not know and I interviewed Gus Sauter, who was probably one of the best interviews of the book because he was there, and he said that the reason he pushed to launch the ETF was because he was trying to figure out a way that if the next crash came he could protect the index fund investors from people who want to trade or go in and out. And so he didn’t do it to increase distribution, which is what Bogle seemed to insinuate when I met with him. It was more to protect the investor, which is right up Bogle’s alley.

Now it did increase distribution, but Sauter said he caught up with Bogle in 2014-ish, what 14 years after they launched the first ETF and told him this and he said Bogle didn’t quite know that. And so I think that’s why towards the end of his life he did soften, and in my last very last interview with him we asked about the ETF again and he said, “You know, if I was running the place I probably would have done it too.” And I know he wouldn’t have, but the fact that he threw that line out I thought he’d come to some general peace with it. But after he says that there’s a dot dot dot but look at all these people chasing returns and trading we still don’t know and all the fruit cases and nut jobs and marketing.

Rick Ferri: So he’s talking about the other side of ETFs, the dark side of ETFs.

Eric Balchunas: I think the ETF industry is a big tent and I think there’s a section in that tent for puritan index investors that are up Bogle’s alley but then there’s maybe fifty percent of the tent that’s wild and crazy and the opposite. People and doing things that he wants no part of and so that’s why I called that chapter “It’s Complicated.”

The metaphor I use is that it’s like Bogle’s first born daughter, like the index fund marrying the tatted up bad boy and Bogle, there’s nothing he can do about it. He’s got to learn to deal with this guy and his family. Yeah and that was how he spent 20 years of his life and that’s why he and Vanguard had this really interesting relationship, where Bogle’s sitting over here in his research center on campus, you know only 100 yards from where upper management is, and he’s sort of constantly dropping bombs on them.

And I found that very interesting, sometimes funny. You know, I think when the ETF came out Jim Wiandt told me– and I didn’t know this– that Vanguard put a press release out and then Bogle put another one out: This sucks. So he’s a character.

Rick Ferri: Interesting that Warren Buffett was one of his biggest fans.

Eric Balchunas: Yeah. I wanted to interview Warren Buffett for the book. I interviewed about 50 people and I asked our people in TV if I get his email and they’re like, okay here’s the assistant’s email, but look he’s not going to reply. If you really want to bother, go ahead try it, just be nice but don’t expect anything. I sent him an email. I got a reply, I don’t know, within about six, seven hours from Warren who said, “Look I’m swamped, but I’m going to help on a couple items about Jack,“ and he answered every question I had.

Warren Buffett is an interesting one because he’s the most popular active manager who’s ever lived and yet he has this interesting kinship with Bogle and I think what they really do share is the Great Depression World War II generation attitude. They’re both very frugal. They don’t need a lot. Bogle’s son was saying he wore the same khakis for 46 years. That’s something you might read about Warren Buffett doing and it was almost like they were cut from the same cloth, where ironically one is the king of active and one’s the king of passive but they’re very similar in every other way, I thought, when reading about him, I think that’s what Warren Buffett was responding to.

And I think as Jason Zweig said, Buffett and Bogle also fought against some of the same forces of like overcharging for under-value and I think Buffett was famous for betting against hedge fund performance. And in some of his letters he’s pretty adamant against how little value some active can actually produce. And so they were aligned on that issue I think and Buffett again was really I guess generous to respond but I definitely was happy he did.

Rick Ferri: I’m just going to go into one more section and then we’re going to wrap it up. And that has to do with takeoffs on indexing and things that aren’t really indexing but are being called indexing to try to jump on the coattails here.

Thank you for mentioning spindexing in your book – phrase I came up with – it stands for special purpose indexing or spindexing, which is everything’s an index now. Because Bogle made indexing and Vanguard made indexing so popular, why not just call whatever it is you’re doing indexing, even if it isn’t an index, and call it that anyway because then you might get assets. For example, smart beta, right, and direct indexing, and ESG and all these things are now indexing. Could you speak to the sort of people jumping on the coattails of Bogle even though it really isn’t what he was all about?

Eric Balchunas: Absolutely. There’s two points I want to make here. One is you’re right. Bogle was not into this. There’s one quote where he said, ”No wonder I wake up some mornings feeling like Dr. Frankenstein. What have I created?” And so he definitely battled against that, again that fifty percent of the ETF tent that’s pretty wild and crazy. That said, this is another interesting part of the book, which is that he kind of created it in a way that’s not really, I think, appreciated or understood yet. Which is that by taking over the core of portfolios, right, a lot of people have now sold out of their legacy active mutual fund and now have a cheap index fund or cheap ETF in the core.

By being so successful with that concept he then pushed active and ways to be active to a complete extreme. So now people who have a boring vanilla core which is highly effective – not all people, I think, you’re maybe in that nirvana stage that you can actually not take the bait on some of that – some people look for things to decorate with, and that’s why spindexing and themes are no joke. They seem like they’re crazy and who cares. But you have crypto, ARKK. ESG [Environmental,Social,Governance], thematic investing, some smart beta. A lot of this honestly is to complement that core now, and that’s why you see the number of holdings in new ETFs come down and down. They’re getting portfolios getting more concentrated. It’’s, again, it’s part of the Bogle effect. By confiscating the core of the portfolio. It’s then made active, have to get more creative and more active.

Rick Ferri: So a barbell type of a thing.

Eric Balchunas: Yes. And I have a whole chapter that looks at that. And so while he would have hated it, again I think he had a hand in creating it by being so successful in the core. He would say just use the core and be a monk and basically have the total index, but some of us are human, and I also think there’s arguably a behavioral hack – if you have a cheap core and it’s vanilla and you’re just the kind of person whose mind’s buzzing all the time maybe you want 10 percent in the crazy stuff. Stuff that has an amazing possible asymmetric return down the road; that’s exciting, it’s entertaining. That’s a narrative driven just to keep your hands off the core. If it keeps your hands busy it’s actually potentially Bogleing in that it’s helping you behaviorally to do that. I’m not sure he would buy that.

Rick Ferri: I wrote about this in my very first book called Serious Money. It’s like you do your core indexing and then you can have what I call bingo money on the side which is your fun money. A small maybe up to 10 percent of your portfolio but that’s it. But I have to tell you, working with individual investors and myself now that I’m in my mid 60’s, it just doesn’t appeal to me anymore. In other words it’s, yeah okay, I was interested in it in the past and all that now and I could see Bogle, see this with Bogle I mean it’s just something that as you kind of get on to pre-retirement and retirement that stuff doesn’t interest you anymore so you end up going to this pure core. Pure core.

Eric Balchunas: Yeah I think you’re right.I think that me, there’s probably going to be some correlation with age. You know crypto, ARKK, I bet their investors are on the younger side and maybe as you get older you get over that stuff. I will say on the flip side there were people like Michael Lewis who I interviewed for the book and and he said something that I thought was really again another amazing byproduct of the Bogle effect. He said, “Once I got my portfolio into index funds I had way more time on my hands. I didn’t have to think about this stuff and that really helped me as a writer because I could just go into my writing head all the time.” And I guess because he was in the financial world he would think about where to put money but once he got the index fund it freed up time.

Dan Egan said the same thing. He now is an advisor, doesn’t have to worry about portfolio. He can worry about the other stuff: planning, taxes, behavior. And that time freedom I think for really evolved investors is big. I just think there are probably some maybe who like the cheap index fund but do want to dabble and they actually like following the market and stuff and for them I think spindexing is sort of – that’s why it exists, because you know you do have some people buying it and perhaps there’s some people who are all in on the crazy stuff and they’ll learn the hard way.

I have a chapter called “The Art of Doing Nothing” and I talk about the Robinhood and the trading and my thesis there is that this is just a generational thing. The ‘90s said the same thing: you’re young, you don’t know, you go through this, the Robinhood army is Vanguard investors waiting to happen.

Rick Ferri: That is absolutely correct. The people who were trading dotcom companies in the early mid 1990s and late 1990s are the Vanguard investors of today.

Eric Balchunas: Yes and I think there’s a line in WarGames² which I think about a lot of is as myself which was, the only winning move is to not play.

Rick Ferri: To close, you wrote that Bogle realized that making money was rewarding. And he realized that making money is rewarding but the thanks and admiration that he received from investors was much more rewarding to him and it was actually, in my view, intoxicating to him. I knew Jack for probably, oh, I don’t know, 20 years. I saw him a lot at the Bogleheads conferences– and we’re starting that up again by the way in October– but he felt that it was much more important to him personally, professionally, spiritually, to be appreciated for what he did helping people than any amount of money that he could have made as the CEO of a mutual fund company. We say around the Bogleheads, you know but Jack Bogle knew he could make a lot of money but he chose to make a difference, and that was Jack Bogle.

Eric Balchunas: He wrote a book called Enough, and he clearly had some gene in him that wasn’t attracted to the sort of thirst for more that a lot of people who go to Wall Street have in them, and it’s just a natural gene, it’s like fire in your belly stuff he just didn’t have that. He was immune to it. But what he could never get enough of was appreciation and adulation. And his son was saying that his whole family never quite understood that part of him. He could never get enough of hearing you know like the guy on the street saying “you saved me money,” whatever. He saved almost every letter. You know he’d – Erin Arvedlund from the Philadelphia Inquirer said he would read letters to her in his office from doormen who put the other kid through college and that’s why I say that in a weird way he might have been miscast. It’s almost like somebody who wants adulation and appreciation would go into the arts or acting or something or be a physician. Bogle was– it’s a good myth– sometimes it’s good to have somebody miscast in an industry.

And it’s also interesting – back to Princeton to go full circle with this – that I found it just crazy that the whole reason he did all this is he’s in the Princeton library looking for a thesis, something to write his thesis on, and he’s flipping through magazines, and he happens to find Fortune, and in the magazine there’s this article on mutual funds in Boston. When he decides, “Okay I’ll do this.”

Well I looked and the cover of Time, which was probably laying right next to it, was Conrad Hilton. This is December, 1949, and had a hotel business, and I thought, “You know, it’s just as easy, he could have picked that up and been like the hotel guy. And it’s just interesting, it’s almost like fate nudged him to this. Because between that and the crazy Wellington story that had like four things that had to go exactly perfectly, and then the index fund isn’t managed. You realize the amount of serendipity, you almost feel like there was some kind of fate nudging this to happen. It’s really crazy, and I didn’t realize it all until I dove into it, just how serendipitous the whole thing was.

Rick Ferri: Well, the name of the book is called The Bogle Effect by Eric Balchunas, coming out April 26th. Eric, thank you so much for coming on the Bogleheads on Investing podcast.

Eric Balchunas: Thank you Rick for having me. And as you know, I am a big fan of the podcast and it’s quoted several times in the book. You really, through your interviews– you’ve got some gems that came in handy in my writing there– so thank you for that.

Rick Ferri: This concludes this edition of Bogleheads on Investing. Join us each month as we interview a new guest. In the meantime visit Boglecenter.net, Bogleheads.org, the Boglehead Wiki, Boglehead’s twitter. Listen live each week to Boglehead’s Live on Twitter Spaces, the Boglehead’s youtube channel, Boglehead’s Facebook, Boglehead’s Reddit. Join one of your local Bogleheads chapters, and get others to join. Thanks for listening.

Notes