“Main Street hasn’t been taking its fair share.”
That’s according to Jack Bogle, the founder of $3.5 trillion fund behemoth Vanguard.
He’s referring to the cost of investing, and the portion of investment returns that finds its way to brokers, distributors and Wall Street at large.
Bogle has been at the forefront of the effort to change that. He launched Vanguard in 1975 and created the world’s first index fund soon after. An index fund tracks the movement of an index, often the S&P 500, and charges much lower fees than funds that are actively managed.
Index investing is set to benefit from a Department of Labour rule that is meant to protect retirement savers from the conflicts of interests of financial advisors. Firms like Vanguard are expected to benefit from the new rule. With President-elect Donald Trump’s win, the future of that rule has come under question, however.
Business Insider caught up with Bogle to talk about the future of the rule, index investing, and the shift in power from Wall Street to Main Street.
What follows is an edited transcript of the conversation.
Rachael Levy: What do you think will happen to the fiduciary rule under President-elect Trump?
Jack Bogle: I’m not sure if I have any great insights, it’s a very mercurial administration. I don’t think they have any idea what they’re going to try to do.
It seems to me, pragmatically, it’s very difficult to step back from a rule that’s so obviously needed.
Who are you making money for — your firm or your client?
Fiduciary means putting the client first, and as I have observed in the past, the only other rule we have is the client comes second.
It seems equally clear to me that it’s only a matter of time that the SEC adopts a comparable rule for all accounts. [The fiduciary rule, set to go into effect in April 2017, only covers retirement money.]
The idea that I have a retirement account with a broker and he takes good care of me, and I have a personal account [and the broker’s interest comes first] just flies in the face of common sense. If his customers don’t have retirement plans, he doesn’t worry about things, he sticks with the whole suitability rule. [Under the current set-up, advisors that have not opted to be fiduciaries only have to provide investments that are suitable, not necessarily in the best interest.]
All of this makes it seems like it will be hard to walk back this fiduciary rule into oblivion.
Expenses have become a big thing with funds. Index funds are taking the huge capital inflows in. Cost consciousness, that’s what lies at the heart of all this. Who are you making money for — your firm or your client? Main Street hasn’t been taking its fair share.
So the trend is to increase the share of stock market returns that goes to investors and reduce the share of stock market returns that goes to brokers and distributors and the whole Wall street apparatus.
We’re reducing the share that goes to Wall Street and increasing what goes to Main Street. The great thing about the fiduciary rule is it moves up the time table.
Financial advisors [registered with the government] are already under fiduciary rule, but brokers are sellers, they live by making trades, they live by commissions. They have been operating under this so-called suitability rule. You can find a perfectly suitable investment that’s too expensive.
Levy: What do you think about the criticism against the rule, that firms won’t be able to service low-balance accounts because of increased compliance costs?
Bogle: I don’t see why that should happen. Firms seem to me that they are dropping front-end loads, but they can get paid on a percentage of assets. There isn’t a lot of cost saving there.
These are good people — they’re not ill motivated, it’s just how the system has worked and the system has worked badly.
The trend is to increase the share of stock market returns that goes to investors
Rules can be changed. I don’t think the DOL and ultimately the SEC are going to want a rule that deprives smaller investors of an ability to save money for the future. What we have to do here is make it so easy to do that you may not even need an advisor.
Levy: Aren’t you going to be a big beneficiary of the rule, because more assets would go into index funds? The rule is expected to push money out of actively-managed funds into passively managed ones, because the costs are easier to justify as in the best interest of the retirement saver.
Bogle: I agree with that. And I would welcome, personally welcome, many more firms to start offering index funds. When you think of the traditional index funds — and I’m leaving out ETFs — I call them TIFs, 80% of those assets are at Vanguard, 10% are at Fidelity and 5% are spread among T. Rowe Price, JPMorgan, Charles Schwab.
Levy: So why don’t more firms want to go into investing?
Bogle: All the money goes to the investor rather than the manager. Thirty of the 50 largest mutual fund firms are owned by conglomerates and they’re in the business to make money for themselves. That’s the American way, and it doesn’t work very well in finance for the investor. So we’re moving into a sea change in the way people invest.
Levy: Why are some of these firms against the fiduciary rule?
Bogle: They realise that this fiduciary idea, one of the highly likely [effects] is to have more people going into indexing, without paying the high prices you get with actively managed funds.
If we have a 7% market return, those who index, which is about a third of the industry, will earn 6.95%. Those who own active funds, will get 7% and take two points out of it, for sales loads, etc. So they will get 5%.
You put up 100% of the investment, you took 100% of the risk, and you got 33% of the return over a lifetime. If investors could just see that emblazoned on the lights of Times Square, this [shift to indexing] would happen even faster.
Anybody is free to compete in the index area. I think we need more competitors, but where are they?
If it’s better for Main Street, it’s worse for Wall Street
If it’s better for Main Street, it’s worse for Wall Street.
I think there will be some bumps in the implementation for this rule. I believe they are rectifiable, and if they are justifiable they will be fixed.
Levy: What do you think in the rule needs to be fixed?
Bogle: I haven’t read the whole thing — it’s 300 pages or something, it’s very awkward, cumbersome. A lot of data has to be kept, a lot of info has to go from the buyer and seller, there’s this BIC [“best interest contract”] exemption, so it’s very bureaucratic. Because it comes from a bureaucracy, that might be the only way to to do it, but if there are places where the shoe pinches, well, then let’s fix it.
The SEC also has an opportunity here to write a tighter rule.
Levy: Why do you think there has been this pushback against the fiduciary rule?
Bogle: Sure, they’re worried about the administrative burdens, but second, I think they’re worried that the fiduciary rule leads to much more indexing, and they don’t want to do indexing. They want to do it at a very high price, which just isn’t going to cut it with investors.
The whole point of the index fund is to give the investor his or her fair share of what the stock market was generous to give us, or mean enough to take away from us.
Levy: What do you think of the criticism of indexing, that it leads to too much concentration, overvaluation of stocks?
Bogle: There is a lot of concentration. BlackRock is probably doing 40% of the ETF business. We’re probably doing 30%, State Street is probably doing 20% or 25%. And that’s a lot of concentration.
Levy: But what about the concentration in stocks?
Bogle: That’s not much of a problem because these funds don’t trade. The amount that goes into index as a value of the total stock market is not that big. It’s not as if the market goes up, the stocks in the fund go up the same way. The turnover in index funds probably runs about 4%.
I would also add, when I was beginning in this business in 1951, the turnover in the market was around 25% a year, now it’s about 200% a year. The market is turning over at [a much higher rate].
There will always be active managers who are keeping the market efficient. And if you want to read a really reasoned and well-written piece, there’s one about indexing as the ultimate form of capitalism, by Cliff Asness [“Indexing is capitalism at its best“].
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