John C. Bogle Of Vanguard

You operate at cost? You still have to pay people. You still have to have computers. You still have to have the legal disclosures. Sure, but we operate Vanguard at a budget of close to $1.5 billion a year, and that is about 27 basis points on $580 billion. Those costs are apportioned among the funds, basically in relation to their net assets (Figure 1). So if a fund is 7% of our net assets, it would pick up 7% of those costs. But there is no premium in there. It is just cost. We all get paid, yes. This is not sackcloth and ashes.

FIGURE 1: COSTS OF FUNDS. Costs are apportioned among the funds, basically in relation to their net assets. Note the comparison between managed funds and index funds.

You are getting paid market rates? Your people are not getting less than anybody else, are they? No, and I am doing just fine. We have a very nice incentive plan in which we are all rewarded in cash terms. There are no options or anything of that sort because there is no stock. Even so, we have the ability to have costs substantially below the levels of our competitors and outperform our competitive groups. So each year, we go through this cycle in our incentive pay. We are paid market rates, or probably less than market rates for senior management, because the incentives for the vast body of the company are market rates plus your share of this incentive plan, which is called the Vanguard Partnership Plan.

But the rest of us have an incentive based on our ability to keep cost below the competitors. For example, if we can operate at, say, 25 basis points and the competition operates at 105 basis points, we save 80 basis points. And if you save that on almost $600 billion, that is a savings to the shareholders of $4.8 billion a year. That is about what we save them. And a very small portion of that is put into this incentive plan.

What else? Second, each of our funds is evaluated yearly on the basis of its performance over the past three years, whether it is above average in its competitive group -- say, growth and income funds, or value funds if you will, or small-cap growth funds, or intermediate-term municipal bond funds. Each fund is awarded a rating -- average, above average, or below average -- for its performance relative to its peers and relative to market indices. That is usually about 20% of the incentive award. Because we are able to outperform -- not uniformly, nobody does that -- it probably contributes 20% to that total pool.

That is the at-cost part. It does include incentives. They are nothing like the incentives we would have if, for example, I owned Vanguard. I suppose I would be worth $10 billion. Well, to say my net worth is 1% of that would be too high. We are all comfortable with that. It is the system I set up 25 years ago, so I am happy with it. It works very well for the shareholders, who are the people we are supposed to serve.

The second cost is portfolio turnover. That is a detraction from returns.

Is that just from transaction cost, or is that also tax cost? That is just transaction cost. I am talking about the investment cost attendant to trading securities. That includes commissions, bid and ask spreads, block positioning cost, and the like. To the extent you can keep that down, you can minimize those costs.

What about the index funds? In the index funds they are very, very close to zero (Figure 2). We can do certain incentives instead of trading toward the end of the day with brokers, and that sort of thing. With the other funds, we have a very good reputation in all the statistical sheets we see -- the rate, the execution cost. So it is basically a low turnover policy. You are not buying a stock and chasing it. More likely, you might be buying a stock if it is going down. It is more of an opportunity technique rather than an in-a-hurry kind of trading technique. But our funds typically have low turnover, compared with the rest of the industry. This industry turns over equity funds at 90% a year, which I think is absurd! If you took everything into account, counting our index funds, we turn over maybe 20% to 25%.

FIGURE 2: INDEX FUND ADVANTAGE. Index funds have an advantage over other forms of funds by minimizing costs.

Index funds must be even lower than that. Index funds are a lot lower. I put the whole bale of them together there. The Total Stock Market Index is probably about a 3% turnover.

What if you had a period when people were pulling their money out? Maybe they're dying, distributing estates, not accumulating money as fast, and you had to disinvest. Would you be faced with more turnover in your index funds? Technically, if you invest cash flow in and out, your turnover is zero. The formula says, "The lesser of portfolio purchases, and portfolio sales as a percentage of assets." So if you take the lesser, it would be the disinvestment. If you had outflow, the lesser would be purchases. In other words, you would be selling more than you bought.

Technically, that is turnover, but we have never had much of a problem. These things do not happen all at once or at least have not happened all at once. We are investing gradually day after day. It could conceivably raise costs, but I do not see it would raise costs any more getting out of stocks than it would raise costs going in if the patterns were similar, which we would expect they would be. So turnover cost is second in keeping the total cost down.

The third factor is opportunity cost. By that, I mean most mutual funds are not fully invested. They are typically about 93% to 95% invested. That means, over the long run, you are earning a cash return -- let's go with 5% -- in a market that's yielded 12% over time. For the sake of argument, that is a 7% opportunity loss multiplied by 7% of the assets; that's 49 basis points you have lost as an opportunity cost.

So looking at those three costs, the first one, the average equity fund, has about 150 basis points average operating costs. We think that turnover cost on average for the funds for these high levels are about 50 to 100 basis points a year on trading cost. Use 75 points as a middle ground as a reasoned estimate; that gets you up to 225. Then you throw in 49 basis points of opportunity cost and you are up to 2.74% of costs -- a hit against returns.

And the fourth cost? The fourth cost is sales charges that fund investors pay to buy in. We have none, compared to others in the industry; about two-thirds of the funds in this industry have sales charges. Depending on how long an investor holds shares, that could easily be half a percent to 1% a year for a longer-term investor. If you pay a 6% sales charge and get out in one year, it is obviously 6%. That's a big hit.

In a philosophical sense, it is clear and certain beyond any doubt that all investors share the total return of any financial market. Stock market investors get the stock market return. Bond market investors get the bond market return. Money market investors get the money market return.

Before cost, though -- Before cost. So it is a zero-sum game. Beating the markets is a zero-sum game before cost and, by definition, a loser's game after cost. There is no way around that. Therefore, it follows that if you own the market and can minimize these four costs, you can get 98% or so of the market's annual return.

So it is really one decision: to be in the stock market or not. Looking at the Total Stock Market Index Fund, you basically own every business in the United States and hold it for Warren Buffett's favorite holding period: forever. You will -- not may, but will -- get 98% of the market's return. Now, the average investor, when you take those one and a halfs and two and a halfs and so on, is probably going to get around -- certainly not more than -- 75% of the market's annual return. An investor in a managed fund, if the costs are 2.5% a year in a 12% market, is going to get 9.5%. It compounds (Figure 3).

FIGURE 3: COMPOUNDING EFFECTS. Aside from whether a managed fund can outperform the market, its costs will inevitably drive it into under-performance as their effect compounds over the years.

Why do people go for this? Well, let me give you what it means, because otherwise that may not sound like much. It means if you invest at 12%, over 25 years you will get 17 times your money. If you invest at 9.5%, you will get almost 10 times your money. So $10,000 at 12% is $170,000, and $10,000 at 9.5% is $97,000.

That is a difference. Now, that's focused on the long term, on staying the course. It's focused not on shifting from growth to value, or large to small, but just owning everything and holding it forever.

I am the first one to admit some mutual fund investors will get more than 12% in the 12% market --

And some will get less. But as we know, the average is going to get 9.5% almost by definition. Your chances of getting more than 12%, beating the market if you look at a 25-year record in mutual funds, are probably about one in 33. So you have one chance in 33 of beating the market.

But by selecting mutual funds -- Now, I have to say I have already messed up my argument here, because there are really five costs. Let's take it after opportunity cost, because they come out of the returns before taxes. Taxes! Let's make that cost 4 and make sales charges cost 5.

And taxes are unbelievable in the mutual fund industry! It is the most tax-inefficient industry ever created by the mind of man. It really is. Taxes during this bull market the last 15 to 18 years have reduced your returns another 3%. So you have gotten about a 12% return in an 18% market.

To make matters worse, mutual funds realize about one-third of their gains on a short-term basis. They don't even hold the stock long enough to qualify for long-term treatment, so it is horrendous.

Why don't people recognize it? Why? The only thing I can say is first of all, we haven't always had markets that produced 18% a year. The higher the return, the higher the taxes. Mutual funds look relatively worse the higher the level of returns because of their activity. The high level of return costs a lot. So circumstances are unusual. You only see it in retrospect after you get those returns for a time but it is going to be a big problem, because even this year, with the market going a little better than nowhere -- a little tiny positive right now -- investors are going to get very large capital gains. Investors who bought in March and maybe have less money now than they had then are still going to get the capital gains, and they'll get the privilege of paying the taxes. I use the example of the casino. In the stock market casino, it is the croupiers who win. Put another way, where are the customers' yachts?

Why are the customers going for this? You have been at this for what, 25 years? Fifty!

Fifty for the index business? Well, 25 for the index business. And clients are going for that! At least you can say that our index fund is the biggest fund in the world.

That is true. Vanguard has enjoyed extraordinary growth. We have, and it has been basically the whole idea of simplicity and parsimony.

Parsimony, the simplest approach. I call it the "majesty of simplicity in an empire of parsimony."

Let's go back to the management of funds. Typically, these are set up by a group of managers who then rake off 1.5% for fees, if not more. The distribution costs, of course, are passed along to the customers. Directly or indirectly.

Is it just the power of sales that makes people go for this deal? Well, it is the power of sales, but equally, it is the power of overoptimism and the conviction you can pick the winners. Remember the Steve Leuthold poster, "Stamp Out Index Funds, They Are unAmerican"?

There was such a poster? There is such a poster, and it's hanging right outside my office. Steve is a good friend of mine. That goes back to the beginning of the index fund in 1975. The poster was first offered in 1976. It's still a good idea.

People say, "Well, it [an index fund] is overweighted in these big growth stocks." I do not know quite what to say about that. Of course it is. So is the market. If the market is the value of all outstanding securities, the capitalized value, you are going to have the most money in the stock with the largest market capitalization. That is arguably a great flaw, but it has existed since the beginning of the Standard & Poor's index in 1926. It's often way overweighted in something. The index was 32% in oil at the peak of the oil price boom in the 1970s, and that was disastrous. But look at the record compared to the managers. It is like the bumblebee. You get all of the designs out and it is absolutely clear the bumblebee cannot fly. But it does.

What about shifting between stocks and bonds? Is that a decision that people should be making? That is an asset allocation decision. I would say just two simple things about it. Of course, it is a decision that people should be making. But since they are likely to get it wrong, they should just fix their proper asset allocation and keep it there. At least, that's my own philosophy. Fix your proper allocation and either leave it completely unchanged, irrespective of circumstances, or change it, but never more than 10 percentage points. Never be 100% in the market or 100% out of the market.

Well, you offer several bond fund maturities. Is that a choice people should be making? Actually, I pioneered the maturity series bond fund back in 1975, with our short/intermediate/long portfolios of the Vanguard Municipal Bond Fund. It was an idea whose time had come and it's now the industry standard. Back then, bond funds were managed, so to speak, to take advantage of interest rate fluctuations, a feat that was evident in the promise, but not in the delivery.

So what does that mean for the investor? Investors can invest in the short-term fund if they seek primarily reasonable income and stability of capital, long term if they seek more generous -- usually -- and more durable income and can tolerate the extra volatility, and intermediate term if they want something of each -- or just can't decide.

The All-Bond-Market Index Fund simply combines all three and, as you might suspect, turns out to resemble the characteristics of the intermediate fund. But no matter what they choose, they should be certain to pick low-cost funds.

Who would go for a high-cost fund, anyway? Only a very foolish investor would own a high-cost money market fund, because the cost is entirely responsible for the difference in yield. The same principle applies in bond funds, if not uniformly over short periods, dramatically over longer ones.

As to "decision points" in investing -- and this may not surprise you -- the most important single decision is how to allocate investments between stocks and bonds. I'd decide to use all-market index funds for both. The allocation should be based on years remaining to accumulate assets; aggregate amount of assets accumulated; current income requirements; and courage to ride out market swings. Maybe 100% equities for a young, confident investor just starting out in a 401(k) plan; maybe 50/50 for a conservative older investor just retired and needing income for living expenses. Today, I'd say no more than 50% stocks.

That first decision should ordinarily also be your last -- but they should be modified as those four factors change, as they inevitably will for all of us as we age. Basically, I suggest following the most valuable piece of investment advice ever offered: stay the course!

Back on the subject of investing -- The reality of investing demonstrated over 200 years, at least in the United States, is that the economics of investing are productive. They are highly productive. Those economics, in the long run, depend not on wild price/earnings (P/E) ratios like we have today, but on earnings and dividends.

The entire market return over time is accounted for by the dividend yield you buy in at, just as if it was a bond coupon, and the earnings growth rate that ensues. The dividend yield is very low now. It is not going to give much support to the markets. We must have very good earnings growth to get the returns of the past.

Why wouldn't we? What would prevent us? The economics are sound. What defeats you is the emotions people have. Emotions are just the opposite of economics. The emotions of investing are counterproductive. Economics are productive. Emotions are counterproductive.

Why are they counterproductive? Emotions are counterproductive because your emotions tell you to do things at the wrong time. You want to barrel into the stock market, for example, on the day it hits an all-time high. It is manifesting great optimism about the future. There may even be a little greed thrown in there.

So what happens when the Dow Jones drops by 6000 points? Down 50% plus. You want to invest then? Your emotions don't like it at all -- "You must be kidding me," they say! At that point, you are thinking about taking everything out of the market.

Which is, of course, counterproductive. So the best thing to do is set a sensible allocation, and that has to do with simple things, like how many years you have to invest. How much money you have at stake. What your risk tolerance is. Can you handle a decline. How much income do you need.

It is not very difficult to say a young person putting his first $150 bimonthly payment into the stock market through his 401(k) plan, with 40 years still to invest, should beyond any question be 100% in equities. But on the other hand, someone who has already accumulated $1 million -- and many, many people will do that, are doing it now, and many more will be in the future, with tax-deferred compounding what it is in these 401(k)s -- if you have $1 million the day of your retirement, you are not going to put in another penny. At that point, you do not want to be 100% in stocks. At that point, you need some income, and maybe something in the general range of 50%, plus or minus, in stocks is about right. If that sounds low, I would say if anything, it is too high. The average equity mutual fund today yields four-tenths of 1% per year.

Whatever happened to dividends? With dividends, first, the yields are low. So your $1 million would give you $4,000 income in mutual funds. If you buy a decent-grade corporate bond fund, you can probably get 7.5%. With intermediate-term bond funds, you can probably get 7.5% net. If you have a low-cost bond fund -- cost kills you in bond funds -- you are going to have $75,000 in annual income. So that's $75,000 or $4,000 to live on -- you should not spend the rest of your life thinking about which is better. Even though the dividend can grow, it takes, I believe, 39 years before that $4,000 dividend grows to $75,000 a year.

So people underappreciate the impact of the power of compounding? That is all central to this. It is compounding and looking for things over the long term, instead of what happened yesterday. That is where the secrets are, if there are any. I honestly believe the secret of investing is that there is no secret, only simplicity. You realize quickly there is not much money in simplicity for the manager. The money for the manager is in witchcraft and legerdemain: "I can do this. Watch me pull a rabbit out of a hat!" Some of them are magicians, or have been.

It's all smoke and mirrors? People are attracted to it. People like to choose magic, and in all fairness, indexing is fairly boring. Look at your portfolio every year if you have to. If you don't have to, don't. And God knows, if you have to, don't do it every day. So it is a different approach; it is greatly enhanced by the fact that you have an enterprise that is dedicated to low cost and has a structure --a mutual structure -- that provides low cost. So it all fits together well and logically.

So if you believe -- and this is the central part of it -- in the long run that investment success is defined by the division of financial market returns between investors and financial intermediaries, you'll want to keep the financial intermediaries' share of the pie as low as possible, because the investor gets more. That's a fact. But it is not much fun.

Yet there is this huge bubble going on. The emotions you cited as counterproductive seem to have dominated the market since 1982. I would say not. The emotions were there in 1982, but I would suggest -- and we won't know this for a long time -- in 1982 the emotions were negative.

How do you figure? We had gone through the 1973-74 crash. That was a 50% decline. That was the biggest decline we know of in modern times, except for the Great Depression and the market crash of 1929-33. There was a lot of shock, and pessimism. The S&P was -- this is an interesting point, I think -- selling about seven times earnings, and it was then at 122. Now it is at 1400 and selling about 30 times earnings. So if the market were still selling at seven times earnings, it would be at seven times 48. It would be around 300. So 1100 points in this market increase have been accounted for by nothing but a change in multiples, and that is just a change in emotions.

So are you of the opinion that the entire change was due to emotion? I do not think the entire change was a measure of the bubble, because I think seven times was too cheap. Probably, it should have been at 12 or 14 times under those circumstances. So it would have been at 200 or 250, something like that. But emotions carry it down too far. This is the story of the financial market, probably going back to Biblical times. It does things in extremes. It doesn't just go down to a normal level and up to a normal level. It goes down far too low and comes back far too high.

Given that phenomenon, our readers, who are engaged in forecasting the psychology of the market, think there are some opportunities out there. What do you think? There is never an opportunity to outforecast the market. It is just a question of chance. If a forecaster says "Get out of stocks," you are going to reduce your equity position. But it follows like night follows day that somebody else is increasing their equity position by the same amount at the same time. So you can win. Any investor can beat the system. But we have a system where there are thousands, maybe even tens of thousands, of advisors out there, people who are managing their own assets, of mutual funds, of pension managers, of insurance companies, of hedge funds. They are all competing with one another. They are all brilliant. I have no hesitation in saying probably every one of them is far more intelligent than I will ever be. Really! But as Warren Buffett says, "When the dumb investor realizes how dumb he is and buys an index fund, he becomes smarter than the smartest investor."

And probably more successful, too. That's right. My own guess is the psychology in the air is far too bullish. If we are not in a bubble, we are in something very much like a bubble. There is no way to predict when it will be pricked. It could have been a year ago. It could have been in March, with that big drop in the Nasdaq. It is hard to know whether the balloon will pop or if the air in the balloon will leak out gradually. But balloons usually pop.

Do you subscribe to the theory of demographics, that this bubble is just because all the cash from the baby boom has to go somewhere? Not really, because every buyer has a seller. I am amused to read, and you read it in the newspaper just about every day, depending on what the market does, that "money poured out of technology stocks into financial stocks today!" What that really means is that technology stocks went down and financial stocks went up. But did money really pour out of technology stocks? You mean there was all that selling and no buying?

Somebody bought it. That's right. Was there all that buying and no selling? Where did the buyers get those financial stocks? I don't know, but I think they bought them from somebody who held them, didn't they? That's my simplistic view. The brilliant people will have answers to that, but I don't. So we have created a mystery, a mystique about investing that overlays everything we do. And people say it is far too complicated.

Is it? I don't understand it. I can explain to them about owning the market. I can explain to them where their returns will come from, not might come from -- earnings and dividends, investment factors on the one hand, changes in P/E ratios, speculative factors on the other. I can predict the former with some accuracy. The fundamentals. I know what the dividend yield is today. It happens to be 1%, and I can guess what earnings growth will be. I may be right or wrong, but if I said 8%, you can say 10%, or 11%, or 12%. If you say 12%, you are predicting a 13% return. I am predicting a 9% return if I say 8%. Then we can talk about whether the P/E will add to that or subtract from it in the next decade. That is the unpredictability of the market. And nobody can do that.

But at 30 times earnings -- I think it is hard to believe the market will be selling at 30 times earnings 10 years from now. Therefore, it follows the entire return you get during the next 10 years, if the multiple is unchanged, it will be 8% or 9%, if you want to use my "one and eight" formula.

If you keep growing earnings at 8%. That is a challenge, but let's be optimistic. We are in a new era, or so I hear. I do not have any certainty about that. The reality is the market is going to generate a kind of investment return that is going to have a rule of reason surrounding it. It could be 6% or it could be 12%, but it will probably be something in that range. Not any point in guessing, because it is out of our hands.

The key is, what is that P/E going to do? The investment return, earnings and dividends, is going to be the market return if the P/E remains at 30. This is very simple. The P/E goes to 20, you can calculate it; you are going to lose 4% from that return. So at 20 times the earnings that you are going to get at the end of this trail, your total return in the market will be about 5%. Warren Buffett, using a very different methodology, comes up with 6%.

For the average mutual fund in a 5% market after taxes, the investor is going to be lucky to get 2%. If so, in that sense, a bond does not look like such a bad investment. A tax-free municipal bond looks like a wonderful investment. And in a tax-deferred plan, an intermediate-term, investment-grade bond fund looks like a pretty good deal. But not the whole hog in bonds, even today.

About 50%, 60%? Well, whatever your gut tells you, really. If you are retired, then 50-50 is kind of my starting point. If you do not think you have the gumption to see it through, or if you need more income, you can move maybe to 30% equities, or 40%. If you are an optimist about the stock market, maybe 60%. I think 70% is just plain too high for someone in those circumstances. But on the other hand, I would not change the strategy for someone investing his first hundred bucks.

Don't you have a balanced fund? We have a number of them.

How do they make that decision since they are serving all ages? That's actually a very good question. First, the typical balanced funds we have are in the middle of this road. Wellington Fund is about 65% equities, and our Balanced Index Fund, which owns a stock market index and a bond market index, is about 60-40. If you don't like that, you can do our Life Strategy Funds, of which there are four series ranging from 90% in equities to around 15% in equities. So you could start with a 90% one and then move to another as you age and become more conservative. This would be easy in a tax-deferred plan.

If you get in a taxable mode, you really want to think about municipal bonds, even people in fairly modest tax brackets, because the spreads are very good right now. We do have a tax-managed balanced fund as well, which is 50% in municipal bonds and 50% in low-yielding stocks. Low yielding because that is a tax-effective thing to do.

So that is an intelligent way to do it if you want to be around 50-50. What you realize, and not to take this too far when you think about cost and asset allocation, is that the two are quite closely linked. For example, I cannot give you an exact number, but if two managers get the same return and one is charging you an all-in cost -- say 2.5% a year -- and one is charging you an all-in cost of 0.2% a year, you can have the same return at say a 30-70 stock-bond position with a low-cost fund as you can have with a 75-25 stock-bond position in a high-cost fund.

Are you sure about that? Absolutely! Let me give you the numbers. They are in my book. In a bullish environment with a return on stocks of 12% and a return on bonds of 8%, in a high-cost fund, if you are 80% stocks and 20% bonds, you will get a 9.4% return. If you are 40% in stocks, half as much, and 60% in bonds, in a low-cost fund, your return will be 9.5%.

Your equity exposure is down by half. Your equity exposure is down by half and all we have done is assume that the high-cost fund has a 2.2% expense ratio -- a quarter of the mutual funds have cost at this level -- and the low-cost fund has a cost of 0.2%. An index fund. How about that?

That is worth looking into. It's mind-blowing, isn't it?

I never suspected that. Do the math. Using returns of 12% for stocks and 8% for bonds, take out 2.9%, and take out 0.2%. You don't even have to do it backward. You can just say, "Okay, let's take 80 and 20, 40 and 60."

What about these Internet wrap accounts that Forbes says are going to be the demise of the mutual fund industry? What's your opinion? I think if this industry does not get its act together, those accounts are going to take over an awful lot of mutual fund business. This industry has lost its way. This industry is operating on the idea there is no competition to it. This industry does not have a monopoly on the affections of investors.

So I like these new accounts when they are compared with inferior funds. But if you look at good funds, I would argue that an index fund is going to be difficult for these accounts to beat.

Like what? A fund that buys the 50 largest stocks in the Standard & Poor's growth index, or a fund that buys the 50 largest stocks in the world, or 75 US and international stocks, something like that can work. It can work better than index funds. For most people it is not going to be worth it, but the idea is to do the buying through one of these Internet networks and hold on. I fear that most people are using such accounts and expecting to move around a lot. But motion creates friction, and friction creates cost, and cost creates submarket returns. If nothing else, I am at least consistent.

You are consistent, and in a speech you gave, you mentioned that cost, time, risk, and reward are the four axes to work on. You haven't talked much about risk here. Is that all taken care of by a diversification of an index fund, or is there something more that investors should be looking at? There are three risks you take when you invest in equities. One is market risk, obviously. The second is objective risk. You thought growth was going to do better, and now you think value is going to do better, that kind of thing. Or you think small is going to do better versus large. It is a sector risk, or an objective risk.

What's the third? The third is manager risk. You pick the right sector, but the manager botches it, or maybe he does better. You don't know. All the index fund does is eliminate two of those three risks -- the last two. Nobody can get you away from market risk. You cannot invest without taking a market risk.

And isn't there any time when you want to say, "Hey, I don't want to be in equities at all"? Never.

Even when the whole country is in a depression? Well, how about 1933? Of course you do not want to have been in stocks, but you could have bought the Dow for $32. Just $32 versus $11,500 today.

That would have been the time to load up at $32. Exactly right. You are making my point, or at least helping me make my point, about the role of emotion. If we only had known. But we not only do not know, but our body and mind give us the wrong signals. You just do not get people heading for the storm cellars when the sun is shining. Or, as someone once said, "Noah had a lot of tough days before the rain came."

The other thing you mentioned was time. You really are an advocate of a longtime horizon. Time is really everything. Time is the way to get the most out of a return in compounding. Time is the way to get the most value out of low cost, because we not only have the magic of compounding returns, we have the tyranny of compounding cost.

The compounding of cost. In one of your books, I was really struck by the impact of cost over time. Not just in one period, but -- No, it's all a time thing. In one year, particularly with equity funds performing at random, it is like coin-flipping. One fund is good one year and another the next, but in the long run, cost is a compelling factor. You can look at it. I have been doing some more work on it right now. You can look at it eight ways to Sunday, but you should always buy your funds from the low-cost quartile. You can array funds any way you want, but I have never seen a study -- whether you are talking about large-cap growth, or small-cap value, or any other thing -- where the low quartile in cost fails to top the performance of the top quartile in cost. Or vice versa. So time enhances return, time reduces risk, and time maximizes the impact of low cost. Time really is everything.

Do you think the way the industry operates now in a way subverts the intent of the Investment Company Act lo these many years ago? I do! In one of the most significant single ways, the Investment Company Act says the directors are required to put the interest of shareholders ahead of the interest of investment advisors. That is right there in paragraph 2.

Typically, the directors are passive. Yes, they are. Warren Buffett said that the Act anticipated that directors would be Doberman pinschers, and what we got instead were cocker spaniels.

You set out years ago to do the job right. Do you feel you have accomplished that? I have tried my best. I am never going to say: "My job is done. I have done it right and the race is over." Never. I do not spend a lot of time reveling in what I may or may not have accomplished. I am trying to get through the day and maybe make things a little better for the shareholder. Maybe explain to somebody the message of investing. My conviction is profound and deep, and to some degree at least, not particularly self-serving.

I think you have succeeded. You could gloat a little. No, I won't. Pride goeth before a fall.

Thanks, John.

John C. Bogle may be reached at The Bogle Financial Markets Research Center, 100 Vanguard Boulevard, Malvern, PA 19355.

SUGGESTED READING

Bogle, John [2000]. John Bogle On Investing: The First 50 Years, McGraw-Hill.

Hartle, Thom [1993]. "Steven C. Leuthold: Fundamentally Technical," interview, Technical Analysis of STOCKS & COMMODITIES, Volume 11: March.

Schweb, Fred, Jr. [1995]. Where Are The Customers' Yachts? Or A Good Hard Look At Wall Street, John Wiley & Sons. Originally published in 1940.