John Bogle, RIP
John Bogle died earlier this year at the age of 89. According to legendary investor Warren Buffett, Bogle created more wealth for investors than anyone else in history. A few years ago, I wrote an essay about John Bogle and the company he founded – Vanguard. Here is a brief excerpt
John C. (Jack) Bogle graduated from Princeton University in 1951 and founded The Vanguard Group, Inc. in 1974. In 1975, Vanguard introduced the first so-called “Index Fund” based on the Standard and Poor 500 (S&P500) stock index. The S&P500 is a market capitalization weighted average of 500 of the largest stocks that trade on the New York Stock Exchange or NASDAQ. Since the total market capitalization of these 500 stocks represents more than 95 percent of the entire market value of stocks traded on American exchanges, the index return is a good proxy for the overall “market” return. The purpose of the fund is to come as close as possible to emulating the return on the index. This is accomplished by purchasing and passively holding a portfolio of S&P500 stocks. Since there is no effort made to time the market or to pick winners and losers, there is no need to hire expensive economists or security analysts. The strategy can be deployed by a single manager equipped with a smart computer. Thus, the expenses of running the index fund are quite small. In fact, Vanguard’s annual fee today for running the fund is six basis points (that is, .06 percent) of fund assets. This compares to approximately 150 basis points for the average actively managed stock funds.
The rationale for creating the index fund was a growing suspicion or awareness that actively managed equity funds produce returns before fees that were no greater on average than market returns. Naturally, in this case the return after fees (the net return to the investor) would lag behind the market return (by, roughly, the amount of the fee). Thus, Bogle identified an opportunity to create a product that should be very appealing to the typical investor – getting market returns at very low expense. Surely, this was an important financial innovation.
It is interesting that Warren Buffett views Bogle as favorably as he does. For years, Buffett made fun of passive investing and the financial theories, notably Modern Portfolio Theory and the Efficient Market Hypothesis, that lie behind it. Representative examples: “Diversification means you don’t know what you are doing” and “I want to thank the Business Schools of America for teaching generations of MBA students to not compete with me.”
Yet, Buffett has also directed that any money left in his estate after giant gifts to the Bill and Melinda Gates Foundation is be invested in Vanguard index funds! How can we reconcile these views? Maybe the answer is that Buffett understands that the portfolio management business is extremely competitive and that it is very difficult to beat the overall market return. However, thanks to John Bogle, it is quite easy to match market returns. Thus, most people, including Buffett descendants, would be better off a passive strategy.
In his Shareholder Letters over the years, Buffett has explained in some detail the key elements in his own investment approach and the lessons he learned from his primary mentors, Ben Graham and Phil Fisher. Ben Graham wrote the definitive text on analyzing bond and equities (named, appropriately, Security Analysis) and a more readable treatise The Intelligent Investor aimed at the serious layman. In one sentence, the essence of the Graham approach is to estimate a range of “intrinsic value” for an individual issue and then wait for the market (the mercurial “Mr. Market”) to provide a market price sufficiently below the intrinsic value that the investor has a suitable “margin of safety.” The defensive investor should aim to compile a diversified portfolio of thirty or so companies matching the criterion, and the overall allocation to equities versus safe investments should be no more than 75%.
Phil Fisher wrote the classic text on growth stock investment, Common Stocks and Uncommon Profits.
He proposed that the active investor run a very focused portfolio, no more than five stocks, and that each candidate for purchase must satisfy detailed scrutiny of size of market, quality of management, extent of research and product development skills, marketing strategy and salesmanship, ultra-competitive cost structure, and so on. Most of the information for this assessment should come from detailed conversations with suppliers, consumers, competitors, and even management itself (Fisher called this process “scuttlebutt”).
Buffet took from Graham the ideas of estimating intrinsic value, letting the market come to him, and seeking a substantial margin of safety. From Fisher Buffett absorbed the value of building and holding a concentrated portfolio of high quality companies.
Both Graham and Fisher managed investment partnerships and lectured on investments (Graham at Columbia and Fisher at Stanford).
Are there lessons for the ordinary investor from Graham, Fisher or Buffett? Can you be a successful stock-picker? You can certainly build a diversified portfolio of individual stocks that has zero ongoing management fee. You can use a number of free, or nearly free, services that allow you to screen for stocks that have features suggested by the masters: threshold profitability, decent value, steady growth, conservative balance sheet. Are you likely to come up with a portfolio that beats the overall market? No, but so long as you own at least thirty stocks from a number of industries, you are unlikely to deviate widely from market returns. And, you will have saved the annual management fee.
John Bogle may even have approved. Apparently, for fun, he liked to do a little stock-picking himself.
