Mutual Fund Pioneer Jack Bogle: How to Fix Wall Street
Jack Bogle, the founder of mutual fund giant Vanguard, and the man who popularized index funds, is part of an older generation of financiers, including people like Warren Buffett, who believe in long-term, low-cost investing, paying their taxes, and giving away most of their money. And like many of that generation, he’s worried about how short-term thinking has corrupted the markets and endangering our economic future. His 11th book, “The Clash of Cultures: Investment vs. Speculation,” is a highly critical, numbers-driven look at how Wall Street went wrong, how it’s screwing up both the economy and our retirement prospects, and what we can do to fix things. He spoke with TIME’s Rana Foroohar about the book, and what’s rotten in the markets today.
Q: There’s so much more turnover in the markets now – exponentially more – than there was in the early 1980s. What changed? How did investing become so speculative?
Bogle: There was a big acceleration around 1980, when companies began using stock options to fund corporate compensation. We moved to a system of compensation that was based on stock prices rather than on intrinsic values. Suddenly, you are paying executives [not to run a company well but] to raise the price of their stock – and that’s a bad innovation. The bull market of the 1980s didn’t help things, because it made it all seem so easy, and you had a lot of new mutual funds taking higher fees. If you have a 17% return, who cares if you are paying 2% fees? People just didn’t worry about costs, which is a bad thing.
Q: Bill Gross, the head of PIMCO, says we’ll never see those kinds of double-digit returns again; in fact, he’s not sure we’ll even see high single digits. Do you agree?
Bogle: Well, I don’t think his view is bearish; I think it’s accurate. [In a balanced portfolio of stocks and bonds] you might get a 7% return. And that’s assuming 2.5% inflation, which could be much higher over the longer term. The bottom line is that we won’t see the kinds of returns we saw in the past and we have to revise our savings plans for the future. People have to save more, and compromise on their quality of living in retirement. Or, they have to earn a higher return. And I think that given higher volatility in the markets, going into higher yielding bonds or stocks, the risker ones, is unadvisable.
Q: Are markets inherently more volatile than they’ve been in the last several decades?
Bogle: They are, although a bit less so this year. Volatility will be higher than in the past, but it always reverts to the mean. Of course, it would help if we could get some of the high-frequency trading out of the markets.
Q: What’s the best way to deal with speculation, from a policy standpoint?
Bogle: I think you can do a lot with tax policy. Income earned by the sweat of your brow should be taxed at the lowest rates, not the highest. Capital gains should be taxed at a higher rate. You could have a transfer tax on stocks to slow down trading. About 60% of all US stock market investment isn’t even taxed at all, because it comes from pension funds, or endowment funds, or mutual funds, which are either tax exempt or passing on taxes to customers after taking their profits. I think we should also do away with carried interest exemptions for hedge fund managers. They pay the capital gains rate [for their work], not the income tax rate. So, you’ve got a system in which the richest capitalists are paying the lowest tax rates. That’s just wrong. It should be changed.
Q: What would you say to people who claim that higher taxes on capital gains would penalize job creators?
Bogle: That’s absolutely not the case. On page 5 of my book, you can see some numbers showing how only about 1% of money in the market is going to new companies via IPOs and other issuances. 99.2% of it is going to traders.
Q: And what would you say to those who worry that higher taxes on those capitalists, as well as on financial institutions, would make our markets less liquid, and thus less safe and efficient?
Bogle: I’ll tweak a Samuel Johnson quote, and say “Liquidity is the last refuge of the scoundrel.” The fact is that most people in the financial industry, on the left, right, and center, people from Lloyd Blankfein to Mary Shapiro, all say the same thing, which is that the majority of capital should go to business [not to traders].
Q: What could be done to ensure that it does, aside from tweaking tax policy?
Bogle: I think you could have a federal statute requiring investment advisors large and small, institutions and individuals in the profession, to observe a fiduciary duty around things like reasonable costs, good corporate governance, and conflicts of interest. I also think that there’s an individual solution, an “Adam Smith” type solution as I call it, in which investors could just start moving their money to places where they get more of a fair shake. And I think you can see that they’ve done that, to a certain extent, already — Vanguard now represents 40% of the entire cash flow of the mutual fund industry. I think high costs [eroding already lower returns] are as much of a risk for investors as the [economic situation] in Europe or China.