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11 September 2017 Financial Analysts Journal Book Review

Don’t Count on It! Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes (a review)

  1. Martin S. Fridson, CFA

This book is a compilation of speeches, lectures, and essays on the financial industry by Vanguard founder John Bogle. He discusses such contributions as the low-cost innovation for which Vanguard is best known—the stock index mutual fund—and the segmentation of bond funds into short-, intermediate-, and long-term varieties.

In a lecture presented in 2004, John Bogle, founder of the Vanguard Group, documented a direct and substantial relationship between management costs and mutual fund returns. Stratifying all funds by expense ratio, from lowest to highest, he reported the following 10-year average annual returns by quartile: 10.7 percent, 9.8 percent, 9.5 percent, and 7.7 percent. A presumption of market rationality would lead one to expect that investors demanded reduced fees in response to this negative correlation. According to Bogle, however, the average equity fund’s expense ratio was on a long-run rise, which represented a gain for mutual fund operators but an aggregate loss for the consumers they served.

In Don’t Count on It! Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes , Bogle hammers at what he labels the cost matters hypothesis:

Whether markets are efficient or inefficient, investors as a group must fall short of the market return by precisely the amount of the aggregate costs they incur. It is the central fact of investing.

Not surprisingly, the book deals extensively with the low-cost innovation for which Vanguard is best known: the stock index mutual fund. When the company first made indexing available to small investors in 1975, critics derided the notion as “Bogle’s folly.” Some denounced it as un-American. Even Bogle’s mentor, Wellington Fund founder Walter Morgan, considered indexing a “wild and crazy idea.”

To Bogle, however, the benefits to investors were irrefutable. From 1945 to 1975, the S&P 500 Index outperformed the average equity fund by a margin of 10.1 percent to 8.7 percent. The difference of 1.4 percentage points roughly approximated the costs incurred by the equity funds, consisting of the expense ratio and portfolio turnover costs. Bogle calculated that the seemingly small amount that intermediaries hived off every year had a huge impact over three decades, reducing the growth of a $1 million investment from $18 million on the index to $12 million on the average fund. As he saw it, the objective was to deliver the index’s return at as low a cost as possible. In time, a vast number of investors came around to Bogle’s way of thinking. In 2005, 30 years after the introduction of its first index fund, Vanguard’s indexed assets stood at more than $300 billion.

The impact of indexing has been so great that a second, hugely important contribution by Vanguard has been overshadowed. Vanguard originated the now standard segmentation of bond funds into short-, intermediate-, and long-term varieties. Bogle was enshrined in the Fixed Income Analysts Society Hall of Fame for this innovation.

The author of Don’t Count on It! does not dwell on such honors, which include being named one of the world’s 100 most powerful and influential people by Time magazine. In fact, Bogle devotes the final section of his book to tributes to four of his own heroes: Walter Morgan, economist Paul Samuelson, investment guru Peter Bernstein, and Dr. Bernard Lown, a Nobel laureate whom he credits with keeping him alive in defiance of a mystifying heart ailment.

Bogle also shows modesty in sharing credit for his contributions to the field and in downplaying his own theoretical expertise. His unashamed display of such old-fashioned virtues, as well as his heretical view that running a business is not entirely about maximizing the wealth of the owners, has earned him the nickname “St. Jack.” That the sobriquet is not invariably intended as a compliment has not induced him to back away from the high moral tone of his commentaries on the financial industry.

Nor can Bogle be accused of resting on his laurels. Don’t Count on It! discusses not only the path that led Bogle to his salutary contributions but also more recent innovations by others that have been far less beneficial to investors. For example, he estimates that the annual costs extracted by U.S. money managers have skyrocketed, from $100 billion in 1990 to $530 billion in 2007, and he deems it highly unlikely that the increase has been offset by greater added value for investors. Bogle blames the proliferation of narrowly focused style funds for an increase in the failure rate among funds, to nearly 60 percent from 13 percent in the 1950s.

As Bogle warns in a note to the reader, “Certain themes recur with some frequency.” This repetition is one unfortunate consequence of compiling a book from many separately conceived speeches and essays. Another is a formidable copyediting challenge, which the publisher has handled well, if not perfectly. For example, a line penned by Horace is said to be two centuries (rather than two millennia) old, and the period 1948–2000 is referred to as a 72-year span. A footnote on page 73 replicates two sentences that appear in the body of the text. Bogle describes a quotation from the Irish cleric Vincent McNabb (1868–1943) as “an old English saying.”

These scattered editorial glitches do not in any way diminish the inspirational quality of Don’t Count on It! In my own case, I felt uplifted as soon as I read the cover. The subtitle incorporates the title of my 1991 book, Investment Illusions , also published by John Wiley & Sons. Even if the allusion was accidental, to be associated in any way with one of the investment giants of the past century is a high honor indeed.


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