Charles Ellis - author of the index fund investing classic, "Winning the Loser's Game" - discusses his new book, "Inside Vanguard: Leadership Secrets From the Company That Continues to Rewrite the Rules of the Investing Business." Ellis answers audience questions, including some life advice for those on the track of early retirement (#FIRE).
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[00:00:00] Jon Luskin: Bogleheads® Live is our ongoing Twitter Space series where the do-it-yourself investor community asks their questions to financial experts live on Twitter. You can ask your questions by joining us with the next Twitter Space. Get the dates and times next Bogleheads® Live by following the John C. Bogle Center for Financial Literacy on Twitter. That’s @bogleheads.
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[00:00:29] Thank you for joining us for the 31st Bogleheads® Live, where the do-it-yourself investor community ask questions to financial experts live. My name is Jon Luskin, and I'm your host. Our guest today is Charles Ellis.
[00:00:45] Let's start by talking about the Bogleheads®, a community of investors who believe in keeping it simple, following a small number of tried-and-true investing principles.
[00:00:53] This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions. Visit our newly redesigned website at boglecenter.net to find valuable information and to make a tax-deductible donation.
[00:01:13] Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only and should not be relied upon as a basis for investment, tax or other financial planning decisions.
[00:01:23] Let's get started on today's show with Charles Ellis. Charles “Charley” D. Ellis is an American investment consultant. In 1972, Ellis founded Greenwich Associates, an international strategy consulting firm focused on financial institutions. Ellis is known for his philosophy of passive investing through index funds as detailed in the investing classic, his book, “Winning the Loser’s Game.”
[00:01:45] Charley, thank you for joining us today on Bogleheads® Live. Your new book, “Inside Vanguard: Leadership Secrets from the Company that Sets the Rules for the Investing Game” follows the journey of the various Vanguard CEOs over time.
[00:01:58] Tell us about your book.
[00:02:00] Charles Ellis: Wow, what a wonderful opportunity, Jon. Thank you for taking me on.
[00:02:04] It's my belief that Vanguard is offering the finest array of investment product and excellent service, and that they are moving towards another innovation, which will be custom tailored investment advice, which almost all of us really do need.
[00:02:24] The book is a history of Jack Bogle and his frustrations, his development within the old Wellington organization that failed in every single dimension. Most importantly, the cultures of the two organizations didn't work, and Jack got fired. The organization that started out as Vanguard, less than 30 people - not allowed to do anything in sales and not allowed to do anything in investment management - just back-office administration, which Jack Bogle never, ever liked at all. That's what he started with. And now it is one of the largest investment management organizations in the world and is far and away the largest mutual fund manager.
[00:03:10] And behaviors have been clearly institutionalized within that organization. And it's been my privilege to be a consultant to Vanguard and then for nearly a decade to be a board member at Vanguard.
[00:03:24] And I can tell you, just so you know the biases, I invest entirely with Vanguard. My wife does the same. My children do the same.
[00:03:34] And it's because it's a remarkable opportunity. And the book tells the story of how that came to be true. Candidly at 225 pages, it's a hell of a good read for almost anybody who's interested in investing. This is an organization that is simply a phenomenon. I've heard about them, I know something about them, but I don't know as much as I'd like to know because I'm thinking candidly of using Vanguard myself.
[00:04:02] There is no better deal than the opportunity to be an investor with Vanguard. So, I'd encourage anybody to read it partly because it's an all-American story. Partly because it's a really good business story. Partly because it's a really good piece of news for people who are looking for investment management talent. Long way around your answer, Jon, but thank you very much for putting it.
[00:04:24] Jon: I had the opportunity to read it on the plane riding back from the Bogleheads® conference last week, so that was certainly a treat. Thank you for sharing that. It was certainly quite interesting to learn a lot of the really specific details around especially Jack Bogle’s journey, having read a couple other books on a somewhat related topic recently.
[00:04:42] “The Bogle Effect” by Eric Balchunas and then “Trillions” by Robin Wigglesworth. And, actually, both folks were previous guests on this show. So, folks who want to check out those episodes, that's going to be Episode #7 with Eric Balchunas, talking about, “The Bogle Effect,” his book. And then we also had Robin Wigglesworth discussing, “Trillions,” his book in Episode #12 for folks who want to check that out.
[00:05:06] But one thing that made your book different from theirs is that you really got into really specific details about the history of the Vanguard CEOs themselves. Not only Bogle, but the other CEOs that came thereafter.
[00:05:20] This question comes from username ‘AlwaysLearningMore’ from the Bogleheads® forums who writes: “As someone with the long view of Vanguard, what are the most pronounced changes - good and bad - that Charles has noted in Vanguard since Mr. Bogle left the helm?
[00:05:37] Charles Ellis: That's a wonderful open question. Let me start with the really big things which I think are important. Number one is that Jack, self-confessed, was a small company guy and Vanguard as an organization with the responsibilities it was taking on was clearly outgrowing Jack's capability as a leader and manager.
[00:06:00] And while he would've been reluctant to admit it, I think he would have said, yeah, that's basically true. Vanguard today is 15 times larger than it was the day that Jack Bogle stepped down from being the leader. And transition that is most important by far, is the transition of the internal management under Jack Brennan, who distributed responsibility to a series of individuals of great talent, who had a tremendous sense of excitement about the mandate that they had to do their particular effort.
[00:06:39] And usually because that was Brennan's style, had two or three particularly talented young people working with them so that the initiative that they could take would be as fully developed as possible. That worked wonderfully well. Second thing is Jack Bogle had, candidly, a horror for spending money. And while you can see that as being an attractive thing on a personal level, in an organization that's competing with others who are spending money in substantial amounts to build in technology, Jack's phobia on spending money on computers - they're just too damn expensive - candidly, it wasn't very sensible because if you amortize the cost to the computing power over time, it gives you a resource at a very reasonable cost.
[00:07:30] But Jack had his great, great strengths. He also had his hang-ups. And one of those hang-ups was the reluctance to invest in automation. And you can't be in the advanced mutual fund business today with anything like the scale that Vanguard has if you don't have substantial capability in computing and the technology power. That would be one of the most obvious and major changes that took place.
[00:07:59] Third would be that Jack really didn't buy into ETFs. He had a misunderstanding from the very beginning. So, he turned down … the original developer of ETFs went to Jack and said, “this is your pathway to a great success.”
[00:08:17] And Jack said, “Not a chance. This is speculation. It's not all that sensible. I'm not going to touch it.” So, for half a dozen years, Vanguard didn't do ETFs and gave the opportunity to competition. Catching up on ETFs and becoming a major leader in ETFs has been another one of those changes that's taken place in the days since Jack left.
[00:08:42] And it's a tremendous tribute, in my view, to the organizational vitality and strength of Vanguard and organization that they could stand up, dust themselves off, and then rise to leadership in ETFs. And boy, have they done a nice job in that area, all the way along keeping the costs to investors, low, low, low.
[00:09:05] There are other things that have happened, but let's keep in mind one of the things that has never changed. You can argue that it's a quirky attitude, but Jack Bogle had a very strong belief of doing the right thing by investors. And it came out of his childhood. It came out of his educational experiences. It came out of his early working experiences and it was very deeply rooted in what he stood for and what he believed in, and that value that he cared so much about continues to be the dominant force for every single decision that's made at Vanguard.
[00:09:43] I speak as a director because I was backstage, and I saw it firsthand. Every single decision has been made with the objective to do right by investors, which is really different from other organizations that have a conflict. They have an owner, and you're going to do right by the owner as well as right by investors.
[00:10:03] Well, that doesn't always work out to be exactly the same thing. So, it's a big, big advantage for Vanguard that they are owned by the investors themselves - granted through the mutual funds - but they're owned by the investors. And there is nobody taking profits out of the organization. So, everything that they do regenerates back into the organization, it makes it stronger and stronger and stronger as the years go by.
[00:10:30] Jon: I remember one line in your book that Brennan was adding computers to help make the firm more modern without telling Bogle because he didn't want to do that. So, that was certainly an interesting note there.
[00:10:41] Looks like we've got our first speaker request. I'm going to make David a speaker.
[00:10:47] David (audience): Mr. Ellis, thank you so much for your time. I was wondering if you could comment on the ownership structure at Vanguard. How important is that ownership structure to the success of Vanguard?
[00:11:00] Charles Ellis: It's crucial. If 100% of your successfulness can be reinvested in the business with nobody taking it out - which is the reality when you have an investment organization that is owned by the investors themselves and serves the investors as their only purpose - you've got a very powerful proposition compared to any other organization.
[00:11:26] That's been what I like to call an unfair competitive advantage for Vanguard, that they recycle as being an unfair advantage for the investors in Vanguard. And it's a virtuous cycle. It goes over and over and over and over again. Repetitively. That if it's good for investors, it will be good for Vanguard. If it's good for Vanguard, it's going to be good for investors.
[00:11:50] That to me is one of those magical characteristics that anybody in his right mind would look for if they could find it. Boy, doesn't it make a big difference to what we all benefit from?
[00:12:02] David (audience): I'd love to hear your opinion, what impact that ownership structure will have on the future of their advisory business.
[00:12:09] Charles Ellis: My opinion is that the most valuable thing almost every investor can get is not the higher rate of return. It's not the safer, assured rate of return of the investments. So, that takes out active management, which sometimes people think, “I might actually beat the market.” Very unlikely, but it's a possibility. It takes out all those like myself who believe in indexing at low cost because that's not the right focus.
[00:12:39] The place that there is a real need is almost every individual investor and almost every institution could benefit greatly from having expert advice tailored to their own particular and unique situation. Helping them to decide what are their realistic options and choices in investing, so that they can find their way with help from an expert advisor to an answer that says, “you are unique.”
[00:13:12] Just as you have unique fingerprints, you have unique DNA, you are also unique as an investor. Your wealth may be similar to some people. Your age may be similar to some people. Your income may be similar to some people. Your attitude towards risk may be similar to some people. Your number of years that you're going to be investing may be similar to some people, but almost nobody is exactly the same way you are on each one of those different variables.
[00:13:43] If you are unique, your investment program should be custom tailored to that uniqueness. My belief that the direction that Vanguard is moving now is going to enable them to do more and more and more and more on custom tailoring the investment service to the unique characteristics of each individual investor.
[00:14:07] Candidly, I expect to get even more value from Vanguard in the future. It is one of the features of the book, “Inside Vanguard” is to emphasize the organizational capabilities and then to clarify how much they've got in the way of financial power to use any way they want to use, and they are looking for opportunities to find ways to use it to increase the quality of the services that they can deliver.
[00:14:32] And this is the area they've got the largest focus on. Looks to me like the future's pretty damn good.
[00:14:38] Jon: I'm going to move to a question I got beforehand from the Bogleheads® forums. This one is from username ‘Riprap.’
[00:14:44] “As a former director of Vanguard, what are his views on Vanguard's move into private equity offerings? Who, if anyone, are these funds appropriate for? Are private equity returns superior to public market equity returns? How do we know this?”
[00:15:03] Charles Ellis: Let's start with the last one. The answer would be yes, but not always. Not by any stretch. Could private equity be a better rate of return than public markets? Absolutely. Wait a minute. Wait a minute. A higher rate of return, but no liquidity or much less liquidity. Is that a trade-off that's really right for you as an individual? It depends on every single individual to think carefully about it.
[00:15:32] If you need to have liquidity and you need to have flexibility, or you just like flexibility, then this would be an inappropriate place to go because you're putting money in, and it's going to have to stay in for a fairly long period of time. Years and years and years. Best I can tell as an outside observer, the way in which they've gone about organizing it is as good as you could find anywhere.
[00:15:58] But the big question is, should you be in private equity investing at all? And that leads to their having a policy that only if you have very substantial assets and resources, should you be qualified and would you be permitted to get into their private equity investments.
[00:16:13] So as an individual, I don't qualify. My church has a pretty substantial endowment. We inquired, and at $10 million we did not qualify. I know that it's a fairly large amount of money that you have to have if you're an institution. Not quite as much that you have to have as an individual, but that's to protect us from ourselves so we don't get into something that we don't belong with.
[00:16:36] I can't afford in my own personal account to have that lack of liquidity. And for most people who are invested with Vanguard, it just doesn't make sense. The trade-off between liquidity and rate of return. Private equity is not a magical answer in the past, so it's not going to be a magical answer even more in the future.
[00:16:57] Does it make sense for Vanguard to be doing it as an accommodation to their clients who would like to be able to do it? I think the answer is yes. And does it make sense for those larger funds to use it? I think the answer is yes. Vanguard has found such an organization and has found a way to get their traditional low fees with that organization, that makes very great sense to me as a pathway towards private equity. But you've got to start with, are you sure you want to be in private equity?
[00:17:28] Jon: Let's talk about bonds. We've got several questions that we had about bonds. This one is from username ‘er999’, who writes: “In his book, “Winning the Losers Game,” - the 2021 version - he says that he owns no bonds, and in Chapter 15 says that, “Bond ownership by most investors is realistically the cost of protecting your investments from yourself and excessive anxieties.”
[00:17:59] ‘er999’ asks, “With the increase in bond yields, does he still have the same advice or does fixed income now have a role to play in a portfolio? If so, what duration does he recommend for bonds?”
[00:18:13] Charles Ellis: Start with when do I think bond investment makes great sense? It's a matter of time. Almost all of us should have as our principle focus when we're thinking about investment policy and portfolio structure, when is the money actually going to be spent?
[00:18:30] Where I would be in favor of bonds is if you had 3, 4, 5 years between today and when the money is going to be spent. Perhaps for a child's tuition at college, perhaps for a home, perhaps for a second home. Perhaps for some really important vacation that you and your family have got your heart set on. There are a lot of different things that are substantial expenditures that families want to be able to make, and you're really saving towards them, and you want to be sure that you don't have the money at risk in the market. That's where bonds, in my opinion, come in best.
[00:19:09] If it's only going to be a year or less, my personal belief is bonds don't make sense. You should stick with treasury bills and recognize you're not going to get very much of a rate of return, but you're not going to have any risk. And that's really important for most of us when you're talking about your child's tuition or the money to buy a home or whatever.
[00:19:28] It's all a matter of time. If you're thinking in terms of, “I'm going to be retiring in 30 years. How much should I have in bonds?” First of all, I start with, your day you retire is the beginning of your retirement. Your retirement period for most people will run another 20, 25, maybe 30 years. So, you want to be thinking about the 30 years now and the start time plus the 30 years that you would be in retirement and for that kind of purpose, in my view, bonds don't make any sense at all except as a palliative or emotional protection against your being all terribly anxious because of stock prices going up and down.
[00:20:14] Most of us look at our investments and we think in terms of the portfolio that we have. The 401(k), maybe we add in some personal savings that are part of our portfolio. And that may be significant. But we look at the securities part of the portfolio and stop right there.
[00:20:35] For the typical American worker coming up to retirement at 65 or 70, typical American worker has got 401(k) with about $200,000, owns a home with a little bit more than but roughly $200,000 of equity value having paid off the mortgage. And the giant gorilla in their portfolio is the present value of their social security payments, which would run twice those other numbers $400,000 or $500,000.
[00:21:14] So, if you look at the total portfolio of this individual, he's got $200,000 in securities, $200,000 in home equity, and $400,000 or $500,000 in social security. He may say, “I've got 60% in equities.” But 60% in equities in one fraction of his total portfolio. It's only 16% of the total portfolio.
[00:21:39] And most of us are way overcommitted to fixed income investments, starting with social security, then adding on our home. Those don't go up and down with the stock market. Neither one of them. And if we could think in terms of that total portfolio, I believe we could train ourselves to not get spooked by the markets going up and down in stocks because our total portfolio is considerably safer or it's more stable.
[00:22:10] If you're younger than just about retirement, then you add another factor, and that's your ability to save in the future. Your earning power is an enormously important part of your total portfolio in financial circumstances. And so, if we could do any one thing that would help almost everybody figure out what they should be doing in their portfolio section, it would be to think about the non-portfolio portion of their total financial picture. And it would do almost every investor a world of good to think about that total picture and not just look at the one segment of it that is the portfolio.
[00:22:48] The old-fashioned idea is you should put your age in bonds. If you're 30 years old, and you're pretty good at your job, and you enjoy the work fairly well, you're going to work probably until you're 65 or 70. If you're going to work that that long, how in world could you put 30% of your securities money into bonds when you've got fixed income in social security, fixed income in the house that you and your wife or your husband are starting to accumulate the savings for, and a couple of other solids. How could you possibly justify putting money in bonds that are going to stay there for 50, 60 years?
[00:23:33] The answer to the question depends entirely on the specific circumstances of the individual. And standard metrics like, “put your age in bonds” doesn't make any sense at all to me compared to, no, wait a minute, who are you? What are your unique characteristics, and therefore, what is the portfolio structure that would match best to you and your unique characteristics?
[00:23:57] Jon: We've got a speaker request. Tecmo, you should be able to ask your question to Charles Ellis.
[00:24:02] Tecmo (audience): Yeah, I just wanted to say really quick, I fully agree. I'm in my late thirties and personally bonds aren't part of my plan, like ever. But my goals are retirement in my forties.
[00:24:15] Jon: What are your thoughts, Charles, on an early retiree? Should an early retiree be investing in bonds?
[00:24:23] Charles Ellis: This is inappropriate, totally wrongheaded, and I know that my mother would say, “don't do it!” But I'm going to make a strong recommendation that you reconsider your life strategy. If your thought is to retire in your forties, the real answer to your present dilemma is not “do you want to work or not work,” in my opinion.
[00:24:44] It's are you in the right field doing the right sort of work? Is it a good match to what your skills are and what you enjoy? But if you don't find work that you really enjoy, candidly, the most important question you could possibly ask yourself on investments is where do you want to invest your time, energy, and skill? And what kind of a career, what kind of a position within that career, would you most want to have to satisfy yourself and enjoy yourself?
[00:25:13] If you're not really satisfied with the nature of the work you're doing, candidly, you should keep looking because the chances are very, very high with the variety of choices that are available to all of us in our society that you'll be able to find something you truly enjoy and enjoy greatly.
[00:25:29] Jon: That is all the time we have for today. Thank you for Charley Ellis for joining us today, and thank you for everyone who joined us for today's Bogleheads® Live.
[00:25:38] Our next guest is Rob Farrington of The College Investor. Until our next episode, you can access a wealth of information for do-it-yourself investors at the John C. Bogle Center for Financial Literacy at boglecenter.net. For our podcast listeners, if you could take a moment to subscribe and to rate the podcast on Apple, Spotify, or whoever you get your podcast. Last I checked, we had 13 reviews, so thank you to those folks who left a review.
[00:26:07] Speaking of thank yous, I'm going to give a huge thank you to Jeremy Zuke, who is our transcription machine because of his lightning quick turnaround, new podcast episodes are simultaneously launched with transcriptions. And thank you to Barry Barnitz and Chris for transcribing past episodes.
[00:26:28] Finally, I'd love your feedback. If you have a comment or guest suggestion, tag your host @JonLuskin on Twitter.
[00:26:34] Thank you again, everyone. I look forward to seeing you all again next time. Until then, have a great one.