John Bogle talked about his biggest mistake during a 2006 interview.
A unique set of circumstances — starting with the “Go-Go” Sixties and ending with the brutal 1973 – 1974 bear market — led him to put his cost matters hypothesis to the test and change the investing landscape forever.
It’s an interesting story with a happy ending and a few lessons strung throughout.
I’ve made a lot of mistakes. One of my life principles is that the only way you can live life is by dealing with what is, and not with what might have been. So that’s the way I’ve tried to deal with setbacks. I’m a rather thick-skinned guy, and I don’t lie awake at night worrying about my mistakes — never have, never will. The curious thing is that certainly my biggest business mistake, or strategic mistake if you will, was my utter stupidity, callowness, and unwillingness to learn from the very lessons of history that I was teaching when I engineered the Wellington merger with the Ivest Fund group in 1966. The Ivest managers were what I call “go-go” managers, that is, very aggressive, and I should have known they wouldn’t be durable. When Wellington, where I was in charge, announced the merger, I got a call from Bernard Cornfeld, who owned stock in both Wellington Management Company and Ivest Fund, saying that if we let the merger go through, he would sue to stop it. My job was to go to his headquarters in Geneva, Switzerland, and try to persuade him that he was wrong. I was just a kid then, thirty-six or so. He did finally back down and decide not to sue Wellington, but he told me, “Jack, let me give you a piece of advice. These Ivest guys aren’t very smart. You’ll find that out, and when you find that out, you won’t fire them — they’ll fire you.” And so they did.
The Ivest merger was a bad mistake on my part, not only in and of itself, but also because I let the aggressive thinking creep into the Wellington Fund, which had the worst decade in its history while that merger was in effect. Relative to its competitors, the Wellington Fund was the second-worst performing of all balanced funds; we’d never been in such a position before. It was very close to a disaster. So I’d put that down as my biggest strategic mistake. Yet, a funny thing happened: If I hadn’t been fired in January 1974, I would not have had the opportunity to start Vanguard in September 1974. While it was a difficult way to get back on the right track and solidify the things that I knew but failed to acknowledge, my biggest failure led to what was arguably my biggest success.
And the rest is history…sort of. To help fill in some of the blanks, the Wellington/Ivest merger had a weird structure. The company had a board of directors, but a separate independent board existed for the funds.
So one board fired Bogle as CEO of Wellington Management Company, while he convinced the independent board to keep him on to run the funds. And Bogle had to come up with a new name:
The Vanguard Group was incorporated in September 1974 and started operations in May 1975. The understanding was the Vanguard was to limit itself to administration and not get into investment management or distribution; those were to stay with the Wellington Management Company. However, for strategic reasons, I decided we needed to be in the management business. I was interested in building Vanguard as a company where we would control the kinds of funds we ran, how they were run, who would run them, to whom our shares would be distributed, and through whom our shares would be distributed.
I thought about the index fund that I had hinted at in my thesis so many years before, which would be essentially unmanaged and so provide a way for me to get back into the investment business. I got these old Wiesenberger books and calculated the average return of the fifty or sixty equity mutual funds that were in business then over the previous thirty years. When I compared the result with that of the Standard & Poor’s 500 Stock Composite Index, the difference was approximately 1.5 percentage points per year in favor of the index, without taking into account index costs. I did calculate mutual fund returns net of expense ratios and turnover costs (but ignored sales charges), which were significantly lower in 1945-1975 than there are today. Then I calculated the two returns — 9.6 percent for the funds and 11.1 percent for the index, or market — and compounded them over the thirty-year period. Because I had to persuade the directors that this index mutual fund was a good idea to pursue, I wanted the results to look impressive. So instead of an initial investment of $10,000, I used $1 million and came up with $16 million of final value for the funds, compared with $25 million for the market over that period. The directors thought I was overstepping my mandate by starting a mutual fund, reminding me that I was not allowed to get into management. I told them that the fund wasn’t managed, and — believe it or not — they bought it.
Shortly after the fund was introduced, Paul Samuelson wrote about it in Newsweek, saying that his prayers for an index fund had been answered but that “a professor’s prayers are rarely answered in full,” citing the fund’s sales commission. However, it quickly became clear — not only for indexing, but for Vanguard, which was striving to be the low-cost provider — that it didn’t do any good to have an expense ratio of 0.25 percent or 0.5 percent if an investor had to pay 8 percent to buy the fund. In less than six months after the offering of the index fund in August 1976, we had moved to a no-load distribution system. When the directors reminded me that I could not take over distribution, I told them that I was not taking it over, I was eliminating it. That was not without a grain of truth, but probably could be considered a bit disingenuous…
When we had the underwriting of the index fund, Vanguard’s assets were approximately $2 billion, of which $11 million was in the index fund. We could, I suppose, have done away with the other funds and been left with an $11 million fund that couldn’t possibly operate efficiently. But the other mutual funds already were here, part of our resource base, so my idea was to see how closely we could get them to look like index funds. That meant hiring experienced managers with a special mandate and a long-term time horizon and getting fees as low as we could. We negotiated aggressively with Wellington and made staggering fee reductions that didn’t hurt them very much because they were all prospective.
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