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John “Jack” Bogle revolutionized the investment industry by opening the first index fund in 1976 to replicate the S&P 500 index. It was not easy to sell the idea of a fund generating average market results. But Bogle has shown that by lowering costs he can outperform actively managed funds.

Eric Balchunas, author of the fantastic book titled “The Bogle Effect. How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions” is my podcast guest today. It’s a semi-documentary book with numerous interviews by Eric, including Jack Bogle and even Warren Buffett. The book described the genesis of a great revolution in the financial world – the passive revolution.

The Bogle Effect — book review

An excellent book documenting how the so-called passive revolution was born, i.e., passive investing. The author, Eric Balchunas, who works for Bloomberg, is a leading ETF analyst in the world. He has compiled numerous statements from some of the most influential people in the industry with whom he has had the pleasure of talking to him, including John “Jack” Bogle himself and Warren Buffett.

The book explains the phenomenon Eric called the “Bogle Effect.” It also dispels many myths around passive investing over the years. For example, Jack Bogle was an opponent of active investing, that the idea of ​​passive investing is based on the assumption that it is impossible to beat the market, that passive investing disrupts the market and will cause a mega-crisis in the future, and many others.

While this is not a book on how to invest, it helps you better understand the concept of passive investing. You will understand why it was created at all and why it is not a temporary fad. Having a better understanding of how and in what we invest, it is easier to get disciplined – that’s why it’s worth getting to know this book.

Meanwhile, I invite you to the interview I conducted for you with Eric. 🙂

If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds.In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.

In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.

— Warren Buffett

In this episode

📌 Introduction
📌 The Bogle Effect
📌 John Bogle — Steve Jobs of the financial world
📌 Bogle was not (always) an opponent of active investing
📌 Bogle and ETFs. It’s Complicated
📌 The art of doing nothing
📌 Bogle Effect in Europe?

People mentioned in this episode

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📖 Eric Balchunas – The Bogle Effect. How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions (transcript)


Jacek Lempart: Hi, Eric, could you please introduce yourself and tell us how did it happen, that you’re a senior ETF analyst for, for Bloomberg?

Eric Balchunas: I started my career as a journalist covering the financial investment world through Institutional Investor magazine and one of the assignments I got there was to cover funds at a newsletter called Fund Action.

So I had this little base of mutual funds starting out my career. And then I went to PR and did a stint in data. And when I joined Bloomberg, oh, 21 years ago, believe it or not, I was in PR for a couple years, then went to data and in data I did mutual fund data and then I ultimately got assigned to ETFs.

So in the Bloomberg terminal, we tracked things like the expense ratio, the name of the fund, the shares outstanding, all that stuff. So just sort of building out the DES pages of mutual funds, and then ETFs, and when I looked at ETFs in like 2006 ish, I was like, man, these things are going to be big. So I really just started to become an expert in all things ETF over the next, like 10 years, and ultimately started doing some, you know, writing on ETFs for the terminal.

Did some TV, some radio and sort of became known as the ETF guy. And then when Bloomberg Research, which is called Bloomberg Intelligence started as a department in 2000… I wanna say 10- ish I started, you know, I would… I contributed to them a little bit and then they asked me to join fully.

So I was asked to come in, and sort of write for them and then ultimately lead the ETF research group within Bloomberg Intelligence. And so for the past, five years, I’ve been writing about ETFs, but I’ve been doing the same thing for 15 years. Now I’m sort of doing it probably in the right spot, which is writing research notes helping to build out functionality on the terminal sometimes…

Jacek Lempart: Right.

Eric Balchunas: Or dashboards, which the clients like, and then going and talking about it. You know, if somebody inside Bloomberg and the media has a ETF story, they want to talk about I’m… me and my team are very good at going on and, and discussing it with them. So I would say I’m sort of an ETF pundit expert research guy, and that’s how I got there, but it was a, it was a… it wasn’t like I went to research right off the bat. I did a little journalism and data before that.

Jacek Lempart: But to me it sounds like a dream job and from my perspective as individual investor the fact that you have access to the Bloomberg terminal is really amazing. And by the way, are you only focused on the ETFs registered in the USA, mostly in the USA or also you are following what happens for example, in Europe?

Eric Balchunas: So I’m probably 90% US-centric, but we have someone in Europe, Henry Jim, and before that Athanasios, who cover European ETFs. So they’re the experts there.

And then we have somebody in Hong Kong, Rebecca Sin, who covers Asia. So they they’re gonna be specific to those regions. But so, you know, I learned from them and I certainly know those places I’ve traveled to Europe a couple times and gotten into the industry there it’s different, different but same.

And then in November I’m going to Australia actually, which would be the first time going that far. I’m not going to Hong Kong yet because the quarantine and it’s not quite easy to get in and out. So I look to get over there more and learn more, but I’m certainly, I’d say 90% of my tweets and my notes are US.

Jacek Lempart: All right. And by the way, I’m Polish, although I lived for 10 years in Belgium and what I found out, and correct me if I’m wrong, but I think you have some Lithuanian origins, right? I’m just asking, because I also, I don’t know if you know, a bit of the history between Poland and Lithuania, so that was just amazing to find out that you have some origins from Europe already.

Eric Balchunas: Yeah. I wish I knew more. I’m probably gonna visit there someday. I want to go there, but I’m like third or fourth generation away.

Jacek Lempart: Understand.

Eric Balchunas: But my grandmother I think the closest to Lithuanian culture I got was my grandmother, and she would have Christmas dinner. And she would have like pirogis…

Jacek Lempart: Yeah.

Eric Balchunas: Glimpses

Jacek Lempart: Pierogi yep.

Eric Balchunas: Some stuff that you don’t see that often, and she had a mug that had the Lithuanian flag. She was a little more into it than I was, but I’m also a decent basketball player, so I think I inherited… Lithuania, always punches above their weight in the Olympic, and there’s this player in the US Valanciunas which I believe my last name, I believe it came from that and sort of got morphed into Balchaunas, so anyway I definitely get in touch with my culture when I watch basketball, because there’s usually a Lithuanian here or there.

The Bogle Effect

Jacek Lempart: Yeah. Okay. Let’s talk about your latest book which is titled “The Bogle Effect, how John Bogle and Vanguard Turned Wall Street Inside- Out and Saved Investors Trillions.

John C. Bogle (1929-2019)

And the book is not just, as I thought initially, that it’s just the Bogle’s biography. But to me, it was really very impressive because it’s more like semi-documentary book and, and you have done a great job interviewing so many people, including Jack Bogle. And also, I don’t know how you did it, but Warren Buffet even is in the book.

So my first question is what is the Bogle Effect? If you could just quickly explain for us.

Eric Balchunas: Yeah. This guy, Jack Bogle set up Vanguard, which is what a lot of people know… that company. And he set it up where the fund investors own the company. And that one decision in 1974 to set this company up like that, changed everything.

It took a while, but it ultimately changed everything, because it allowed Vanguard every time they got a lot of assets, the shareholders who are the investors voted to lower the fees because that was in their self-interest. So the fees slowly came down over 45 years and now they’re like, you can get a broad market exposure to stocks and bonds for like 0.03%, right.

Three basis points, as we say.

Jacek Lempart: Yeah.

Eric Balchunas: Than, once it, once it got below 10 basis points in like the 2006, 2007, the flows really started to come in. And once the flows started to come in, everybody else has been forced to get cheap and offer cheap index funds and cheap ETFs like BlackRock, Fidelity, even Goldman Sachs, JP Morgan, Schwab.

And when they do they get assets. So what would happen is the Bogle Effect to me is not just that Bogle set up Vanguard, Vanguard became a huge success, but it’s the impact on everything else as well. Most of the money invested today in America goes to either Vanguard or people who copied them.

Then you look at Vanguard as getting into the wealth management business. That’s gonna be interesting. Vanguard, I think also changed behavior. I think a lot of advisors now are more disciplined. They don’t sell as easily. I think a cheap index fund makes that easier. I also think, like in the case of trading and behavior, Bogle was very much against trading and I look at that a little bit.

And he would’ve obviously not appreciated the whole meme stock thing, but he, he didn’t like trading in even big ETFs, like SPY, but ultimately this guy purposely wanted investors to win and to have cheap products and everybody else copied Vanguard, because they had to. And most of wall Street’s general inertia is to see how much money they can make.

And there’s nothing wrong with that. It is a business, you have shareholders, and in the book many times I talk about how I would’ve done the same thing as active mutual funds. I wouldn’t have shared economies of scale. I wouldn’t have lowered the fees. I would’ve just loved the money that that was.

They’ve got really, really wealthy. And they made a lot of money for many years, but Vanguard has just totally disrupted them. Because people just sort of waking up being like, “wait, I’m paying 80 to a hundred basis points to underperform, when I could just buy the index at five basis points”, all of a sudden it’s like, it’s a no brainer.

So Bogle won the hearts, minds and dollars of the American investor. And it’s slowly spreading it overseas. And so this is the Bogle Effect and it’s gonna have a profound effect on investors and the industry. And I find it interesting. I also found it just, again, unique and interesting that nobody copied the Vanguard structure to this day, yet it has such a big impact on everything.

And so I wanted to trace it out. Because I see the data all the time. I’m an analyst and I’m just like, man, a lot of times I look at the data, the annual flows, and I’m like, “damn, almost all this, you pull the thread on it and you end up in 1974 and this guy’s decision to set up a company that was owned by the investors”.

Way more important decision than indexing. Indexing is almost just the lucky byproduct of what Vanguard structure, which again, lowered fees. If indexing didn’t exist. I think Vanguard would be very big active manager because they’d have cheaper funds and they’d outperform more. So it’s really about cost.

John C. Bogle’s handwritten notes laying out options for Vanguard’s corporate structure.
(source: Vanguard)

That’s why I think Bogle’s mis-tagged as the father of indexing. He’s really the father of low cost. And I wanted to set the record straight on that as well, and really just look at how the big trend and the one he set off, and the one that’s gonna keep going and going is high cost to low cost. And it it’s because every other trend there’s some nuance, you know, active to passive ETF mutual fund.

Some of these things are a little more, more gray area then it’s not as clear, but what’s clear is people now want to everything to be cheap and who can blame them. It really adds up over the years. Even that every little basis point counts, especially as your money starts to compound. So I also thought he was an interesting character.

I interviewed him three times before he passed. In his office and he had… he wanted to debate and spar on these different issues going on in the financial arena. And so I had really good lively, like three and a half hours of fun debate with him. And his last interview was six months before he passed away.

And he was pretty prophetic. And I remember after he died I said, yeah, man, I really should get some of those words on paper. So it was the combination of the data I had that blew me away, plus the audio of the actual guy and I wanted… so I put those together. And as you said, I interviewed a bunch of people, 50 people, in fact, and I wanted this to read like a documentary, like a VH1 “Behind the Music” or something, because I was always surprised nobody made a documentary about him.

It’s just baffling to this day. There’s documentaries on way lesser important things in the financial arena. So I was like, in fact, actually pitched this book to somebody recently. I’m like, if you wanna make a documentary of this, it’s already written, as you read it, I’m the narrator.

And these people come in who are not me and give their take on it. And it was written to be exactly like a documentary. So I’m glad you said that. So maybe someday it will, but this is sort of why I was motivated to do it. I thought people some people know Jack Bogle but even those people, I don’t know if they know the extent to which the impact he had or the extent at which indexing really is getting way too much credit for the index fund revolution.

And I think, I think I communicate that well in the book. And also just a character study of somebody who is very unusual for this industry, a weird guy.

John Bogle — Steve Jobs of the financial world

Jacek Lempart: Yeah. You put a comment in your book that boggle was similar to Steve Jobs, of course, in a different industry, but as for example, Jobs, he didn’t invent the personal computer. Neither did Bogle invent the idea of indexing.

Eric Balchunas: No, that’s right.

My question is in the end how he was able to sell such a, let’s say boring idea of selling the, the product, which is giving you average results, because that wasn’t that, I mean, now we can see it’s so easy, right, but in the seventies that wasn’t that obvious.

Jacek Lempart: Yeah. He didn’t have the internet where information was available. People didn’t realize their active funds were not that great. And also in America, we are like, “we want the best”. You know, it’s like Top Gun and Maverick and all that.


The first index fund

Eric Balchunas: Like it’s in our culture to be like number one and active funds are, seem like a better way to be the best. So he had to sell something that seemed communist and average and … So I have a whole chapter where I go and talk about the many ways he had to labor away and try to make cases for indexing. And it wasn’t easy. It also wasn’t easy because when the index fund was launched in 70… I think it was 76, they, they took all the commissions away.

In other words, Bogle was one of the first people to not use your money, to kick a broker, to give a kickback to a broker, which is how much of the fund industry worked and was built, by payoffs. It’s essentially a bribe, to be honest. He didn’t do that. You had to leave the system and go to Bogel if you wanted his index fund. That was pretty ballsy, in my opinion. That also increased the difficulty of selling it because, you now had to… you had to sell so strong that somebody was willing to leave the whole brokerage system and go right to Vanguard to buy it. And so it took a while. And so a couple of things he did was he said, here’s this chart of a growth of $10,000. Here’s if you get 7% a year and here’s, if you get 5% a year. He said an index fund will give you 7% a year.

That’s a 60/40 with no with no friction, no costs. No turnover, no trading costs inside the fund and no expense ratio. 5% is when you add in the manager’s fee and the turnover inside, the trading costs. You take 2% away. It doesn’t seem like a big deal, 5%, or 7%, to most people. But as you compound, in 50 years, on one, you have $350,000 and the other, you have like $150,000. Huge gaps.

That chart to me did a lot for him. It did a lot to sell his case. I also think over time while an index fund may seem average, the longer you hold it, the more it climbs the charts because active funds tend to fall. So an index fund tends to be in the top 10% of all funds over 20 years. So it is sort of a, a top manager.

In fact, he has this fun quote saying, I’ve had this dream where I didn’t tell anybody it was an index fund. I said, I managed it. And after 20 years I became the greatest fund manager of all time, because my fund was at the top. And it’s an interesting way to put it.

Jacek Lempart: Yeah.

Eric Balchunas: So it was a way to win, but it doesn’t seem like it, and it just, you had to sort of shift things in people’s minds a little bit. And he did. And I think over time people’s experience, I think also helped. They saw active managers, maybe not helping them in a bear market, and they saw index funds doing very well in a bull market and, you know, experience.

And a lot of the media started covering it. When the internet kicked in that helped a lot, but it really took a while. I also think what he did, that was really smart was that he would say, look, the market seems like a casino, but here’s all that’s going on. It’s a circle of people trading with each other.

So half the people are gonna win, half will lose. And then if you take the cost away, only a third can win post costs. And then as the year goes on, that third becomes less, and less, and less, and less until there’s really no winners. And that’s just the math of it. Right.

And we’re not here to beat the other guy. All we have to do is hold these companies for 40 years. For a long time. Because I think what he also did was he said, there’s two kinds of return. There’s the investment return of a stock, which is the cash flows… the value created by all these people going to work every day. And ultimately you get a dividend, right? And then their earnings can grow and, right, those two things make up your investment returns. And those are pretty steady every decade. That is investing in American capitalism. That’s why Buffet and Bogle both love equities, but do not like commodities, because there is nothing like that in commodities.

A share certificate for First Index Investment Trust, the first index fund available to individual investors.
(source: Vanguard)

Jacek Lempart: No dividends

Eric Balchunas: So, he was just like, stop pretending you have to beat the other guy or whatever. Just lock into those investment returns and let them do their magic.

But what happens is every decade, the stocks go up because… he called that speculative return. And it makes it look like a shiny object, but then they crash. And people kind of buy high, sell low, and he’s like, let’s forget speculative return. That’s gonna come and go. When you look at, when you add in speculative return over the decade, stocks are up one decade down the next, up the next down the next. But if you remove the speculative return, the investment returns are steady. And I think he also tried to get people to say, that’s what we’re doing here.

We are not trying to beat the other guy. We’re just… If we all invest together in these stocks, we will win long term. And that was a way to, I think, say, okay, if I can sell you on that, what’s the best way to accomplish that? A cheap index fund. So I go through a lot of these ways in the, in the book. One of the stats that blew me away is 97% of Vanguard’s assets came after he stepped down as CEO. And like Steve Jobs, 83% of Apple’s market cap is after Jobs left. So these guys toiled around in a long time as, as building a foundation, you know, not totally an oblivion. But once they, they built it and it was squared and sturdy, boom, you could go straight up with it.

And that I think is, is really the business case study here in the book. It’s not just the book about investing, but really about an idea, a vision sticking to it, being patient. And even Bogle, he said the years of struggle were really rewarding, but the years where the fish jump in the boat don’t do much for me.

So I think I want people to take away that, that message as well. I, I think this book is bigger than just mutual funds as you read.

Jacek Lempart: Yeah.

Eric Balchunas: I think there’s a really interesting case study there. But just like apple completely changed all of tech. You know, Microsoft immediately came out, their little iPad, Bogle did the same thing.

But I also say, I say he was a cross between Steve Jobs and Martin Luther. Martin Luther, that obviously started, the Protestant guy, put that thing on the church that, you know, and he challenged the church within the church and he, he made good points and he created a whole sort of religion. I think Bogle did the same thing. I think he created like Bogleism which is low cost, simple.

And he would talk down and challenge the industry from inside the industry events. And so I, I do agree that he made the products that were practical, like Steve Jobs. And he also created something of a religion that I think will be around for quite a long time, because it’s a like good religions. The people feel it works for them. And I think that’s what Bogleism does. It’s not about him. It’s about the people win. And so I think this guy is. You know, I try to be out first, but I think there’ll be many books about him. And I think he’ll go down as like one of the all time greats, if not the most impactful human for the, for the investor and even the financial industry in the last a hundred years.

Bogle was not (always) an opponent of active investing

Jacek Lempart: Yeah, it was very interesting to read in your book that the creation of the first index fund actually wasn’t associated with the efficient market hypothesis. And to me, it was quite surprising because actually Bogle, as I could read in your book, hadn’t even heard of it when he started Vanguard.

So actually that wasn’t the major trigger to him that there’s efficient market hypothesis. He was actually even an active manager before Vanguard in Wellington fund. So actually he had nothing against active investing as such. Right. He was just saying that cost is everything.

Eric Balchunas: Yes, his son was an active manager. Vanguard has plenty of active funds and the Wellington fund in particular gets the most coverage in any of his books and that’s active. So he was… And he wasn’t even necessarily anti high cost if you’re starting out and you are a small firm, you may need to charge 1% because 1% on a million isn’t that much and you need it to, to keep the lights on.

Jacek Lempart: Yeah.

Eric Balchunas: What he, what he was really railing against was if you broke your fiduciary duty or, and you were a bad steward of other people’s money, and that definitely started to correlate with the active mutual fund world, because they kept that 1% fee, even though they had 30 billion in the fund.

And that, if you… 1% of 30 billion is, is an absurd amount of money to run a fund. They should’ve lowered the fee as they got bigger. Still would’ve made a lot of money. And I think that’s where they missed an opportunity and Bogle that’s what Bogle did. He kept lowering the fee as they got bigger. And he really, really built up trust and goodwill with the clients for that.

And that’s why he did it even with his active funds, which is why another theory in my book is if indexing never was a thing, Vanguard would be the biggest active mutual fund company, six times over. Because their funds would be cheap way cheaper and they’d be bringing a gun to a knife fight and they might not win every year, but over 30 or 10, 20, 30 years, the Vanguard funds would… active funds, would slowly rise to the top simply because they were cheaper.

And I call that Bogle metrics. Bogle, when he looked at active funds, he was less interested in the exact strategy and the formulas, as he was in the costs and how much they traded. So he wanted to remove turnover and expense ratio, just like in sabermetrics in baseball, they look more at slugging percentage and on base percentage than batting average, which is more sexy.

So I look at Bogle metrics are how he approached active. But he wasn’t anti active or even high cost. He was just anti being a bad steward.

Jacek Lempart: Right.

Eric Balchunas: It just happened to be that over time. I think the, the active mutual funds, when they got really big, he accused them of being bad stewards because they weren’t sharing kind of this economy as a scale.

And also, I think if, if Fidelity, if, if like these big companies had passed on more of the economies of scale and lowered the fees, they would’ve been better performers too. And I think the active name would be better. Because right now active’s got this bad name of like their inept. They can’t outperform. If they had lower fees, they, they would’ve banked Goodwill and performed better.

And I think Vanguard wouldn’t have been nearly as disruptive. So it’s also a business case study in, in making sure you aren’t disruptible. Active managers made themselves very disruptable by, I think, you know, they, the money was so good. It was hard to, you know, I understand. I mean, you get a lot of money. You wanna expand the company, hire people, give yourself a raise. It’s I just that’s why the books on this guy, he was different. And so yeah, I, he definitely wasn’t anti active at all. Although over his years he definitely leaned more into the index fund. He just thought that was probably the better way to do it.

But another one more thing on the active thing, Wellington fund was a fund he ran at Wellington and then now it’s under Vanguard. That fund came out a hundred years ago, right. So it’s a hundred years old. There’s about 10 funds that I call them like the early pioneers and of all those 10 funds. Wellington is like, Wellington has like 90% of all the assets of the early 10 funds. And it’s active, which in my opinion, I think proves my theory that if indexing was never a thing Vanguard would crush and be massive in active funds. I think the Wellington fund being the biggest of those early guys is a good indicator of how Vanguard would’ve done as an active manager only.

It’s also a good indicator of how big Vanguard could eventually… Wellington again, Wellington under Bogle’s care for all that time. Again you do the math 90% of the assets, the other ones, a lot of them faded away, busted, got merged. The ones that are left don’t have much assets at all.

Bogle and ETFs. It’s Complicated

Jacek Lempart: So why Bogle was so much was so much against ETFs and actually when he stepped down, I believe in 1996, the first ETF launched by Vangard was like three, four years later.

And you even have a chapter in your book titled “Bogle and ETFs. It’s Complicated”. Why he was so much against that idea.

Eric Balchunas: Yeah. It is complicated because ETFs have really distributed the concept of indexing. Greatly. Even some of Bogle’s closest friends like ETFs. They think, you know, they tried to tell him, Jack, this has really helped low cost in indexing, but the problem with ETFs, he didn’t like the trading.

He didn’t think you needed anything intraday trading. So it was just against his whole thing. He wanted low-cost and he wanted you to hold it for a long time. So the idea of taking an index fund and trading, it just seemed like against his religion. I equate ETFs… I think like the index mutual fund for him was like his first born daughter. And once it got ETFized, it was sort of like her marrying the tatted- up bad boy. And so here it was always… now you’ve got this, this thing in the family and he had to deal with ETFs. And on one hand he would say something like, “well, broad market ETFs are fine, as long as you hold them”, but then he’d be like, “well, but do we even know people are holding them?”

You know, because the trading volume’s pretty high in ETFs. So he could never, ever get comfortable with them as a concept. And you know, that really created a lot of friction between him and Vanguard the company. Him and his protege and him in the whole industry. And he just, he never really got settled on that.

I think he softened a little as the years went on and he saw that Vanguard ETFs were really low turnover. Not a lot of people trading those. I think that gave him some comfort. But yeah, he wasn’t a fan. I talked to a lot of advisors and people who really like him. They’re long- term investors. Most of them do not feel tempted to trade ETFs.

Like they, they have enough discipline to buy VOO and like, just hold it. So I tried to tell him sometimes that the volume in an ETF could be, it could trade like say a hundred billion dollars in a year. But like 90% of that could just be some big institutions moving it around a little bit. And like 90% of the people in it could just be holding it.

You don’t know, volume is not a number you can like unpack. But he would just look at that blunt volume number and say, everybody’s trading it, but it’s not true. Not everybody’s trading it. So he, I think he acknowledged that, but he still couldn’t get over the volume numbers being so. He just, it just, he didn’t like it.

So I always tell people, if you think just because you can trade an ETF intraday that you’re gonna be tempted to trade it intraday, don’t use an ETF. But if that isn’t a problem for you, ETF’s fine. In fact, they’re easier to access in many ways. They trade, no commission. So you buy it free of cost. They’re cheap. There’s no problem with that. But you know, to his point, if you can’t handle temptation, maybe better to find index mutual fund instead.

Jacek Lempart: And what do you think about all these, let’s say non-plain-vanilla index ETFs, like smart beta ETFs and actually the active strategies which are wrapped with the ETF label.

Do you think sometimes that it goes too far or is it a good direction, because what was also surprising to me is that even Bogle in the eighties, he was a pioneer in the quant strategies. So he was actually creating such strategies. So we can say that it was the first beta fund. He was, I mean… smart beta fund, he just invented in the eighties already, before even ETFs were invented.

Eric Balchunas: Yeah. This is a fascinating part about Bogle, so when he was launching the Vanguard index fund back in 1975, he quickly saw that you can actually have index funds that track bonds, international markets. You can have index funds that track the value, half of the S & P 500, the growth half. And so he launched a whole bunch of funds. And a lot of people like that, if you really like growth stocks, VOOG I think is like, or VUG is growth, and then like more concentrated growth. They’re both under five basis points at this point.

So it’s pretty good. You can get smart beta ETFs for very low cost. His problem though was over time, he just sort of, he, he just saw that there’s just no way to, to win. And he got settled into this concept that, you know what, everything’s just a distraction. Just buy the total market index fund and don’t ever sell it and you’ll beat everybody or buy the S & P 500. But this idea of like trying to buy value and then growth, and people were buying it at the wrong time and ended up not outperforming the S & P he just soured on everything, even things he launched, which I thought was really fascinating that this guy pioneered all these areas and then took a crap on them later.

Jacek Lempart: Yeah.

Eric Balchunas: And that also caused friction between him and Vanguard, because Vanguard is sitting here trying to sell these funds and like their clients own them. And here is the old guy, in his campus office, saying this sucks, you don’t need it. International is a great example. Most people are like international and you can now get it cheap international through Vanguard, but he said there’s no need. And so that’s also something very interesting about this guy is that you could, you just get the feeling he just didn’t care about the money. Like he… because if you really, he just spoke his mind and to come to this simple answer of just by the total market, the beauty of it is it’s so easy to do. But this guy went through this whole journey to arrive at this sort of Nirvana space of total simplicity and low cost.

And now anybody can just skip all that journey and just buy it and just trust the guy. And, but you don’t have to, you can do other things. A lot of people who are Bogle- heads, they do international and maybe they have a little value stock exposure. It’s not illegal it’s okay. But he certainly was almost dogmatic in his simplicity at the end. And that put him at odds with everything. Which is like, again, I was fascinated by the story in that he was friction, you know, he was basically in these war of worlds with his own company with, on the campus. And I don’t know, just the interesting guy. He was just lived and… he, he just kind of like spoke his mind and lived in this tension with the whole industry and his own company for a long time.

But there are some worries about passive investing and some of them are maybe just not really worries, but there are some worries which were even worrying Jack Bogle, for example, that the bigger, the Vanguard was becoming the more votes they had.

And for example, now the big three, the BlackRock… Vanguard, BlackRock and State Street, for example, in Apple, they have like 15% shares the, votes. So basically. There’s a question. What then? I mean, if they will start controlling more and more than the companies, what such big companies will do with it.

And is it somehow really changing the market that we have such a big players, which are really having a big amount of votes?

Yeah. This is probably the one thing that is ultimately gonna get regulated. You know, the, the rise of indexing is way over, like people fearmongering on so many things. It’s all bullshit.

Jacek Lempart: Yeah.

Eric Balchunas: The one thing I think that’s going to actually be a legitimate point over the years is how much does Vanguard and BlackRock own of most of America’s companies. Right now Vanguard owns like eight, 8-9% of most stocks. And BlackRock’s another like six, 6-7%. And ultimately that’s gonna grow because they take in the vast majority of all the new flows. So you can see them at 10, 20% of ownership of companies. That’s a lot of voting control. The government’s probably gonna be concerned about that. So I, that’s why we have a, a theme that we write about a lot in our research calling. The only thing that can stop Vanguard is regulation in our opinion.

And it probably will happen. I asked Buffet about the same question he said, it’s fine, I’m not really worried about it. It’s probably gonna be a regulatory issue for another day. So I do think somewhere along the lines, they might say that, you know, Vanguard, BlackRock have to just stop taking assets in like they it’s over the rule right now is a fund can’t own any more than 10% of one stock, but a fund company, it doesn’t apply to it.

So their total market fund from Vanguard, I think owns 3% of Apple. So it could grow three times and still not hit that ceiling. So Vanguard could effectively grow three times as big as it is without really having a problem. And then they could just open a total market part two fund. So you could see how they could just keep going and going.

So that’s why I think some government rule regulation is probably gonna have to come in. That said, I don’t think they’re horrible voters. I think they vote pretty neutral. They try to vote with management most of the time, and when, when faced with should the CEO have like performance metrics?

They usually say yes. So I think they are careful to vote in a way that would help all of the shareholders in the index funds. They have group, corporate governance groups. They look at the, each vote, take it seriously. Some people on the right think they’re too a ESG and some people on the left think they’re not ESG enough.

So they’re constantly getting attacked from both sides, but I find them to be pretty, okay. I think, and there’s a good deal of people who use their funds, who don’t… they’re like, I just, honestly I want the cheap index fund fund. I trust them. It’s a big media story. But I think it’s probably the one thing we’re gonna keep hearing about.

And the one thing that probably will cause regulation, but it has nothing to do with active and passive. It’s just the fact that one company and two companies are having that much control it. It has that monopoly type feeling that that tends to cause reg, you know, get regulators’ and legislators’ attention in the US.

The art of doing nothing

Jacek Lempart: All right. I’d like to talk about the art of doing nothing as you described that in your book. We all know the, the big short, but you were writing about the big long and you claim even that the young day- traders will eventually convert into conservative buy-and-hold investors that, that actually happened to you as an investor.

So you also were day trader, maybe short term investor and you converted into the long term conservative buy- and- hold investor. Could you please elaborate, elaborate more on that because that’s interesting. I think especially now, because even when I started investing In Europe, ETFs were not that popular, but now I see even young people which are already starting with passive investing and just starting being very conservative, because they already had the chance to read about all this bullshit with this day trading and stuff. And they are already from the very beginning focused on the long term.

Eric Balchunas: Yeah. Young people in a bull market, their friends show them the phone. Look, ’em up 3% today. I, you know, and you go to a bar, same thing happened with, in my generation, it was stocks like Oracle and Cisco and Microsoft. Those stocks would be really powerful.

And in the nineties, I, you know, we were, it was it, we were into it, but then there was a crash, basically a bear market. And we realized it’s not as easy as we thought. And then we also, you know, started buying houses, getting married and you realize you can’t just trade your money away. So I think it’s a young person’s game but it’s okay if you’re older and you want to trade and you look at it as like recreation just it’s legal.

I have no problem. I mean, it’s fine. I just think overall young people don’t have the experience of a bear market to know that they’re not geniuses. Right. And it’s harder than it looks. And so I think that’s, what’s going on with the meme stock crowd, and even some of the crypto people is that they… the fed was like pumping up the market.

It was a very good time to be an investor. Everything seemed to go up a lot. Now. I think it, that retail percentage of trading is coming down. I think a lot of ’em are like throwing the towel in surrendering. And I, I think they’ll a lot of ’em do end up at low cost index funds which to me are… it makes being long term investor easier?

I think the big long advisors as I call them are advisors out there, they’re younger, they’re fiduciary. They use index. And they tend to really interpret news flow as like trying to bait them to do something. And they’re like, I’m not… you know, they have just learned to just hang in there. But I think also just having a low cost index fund makes it easier to hang in there because think about it.

The market goes down, you’re in a three basis point total market fund. You think to yourself, In the nineties, you’d be in an active fund and you’d think, well, I should go to a one that’s winning. Right. And then you switch and then you switch at the wrong time. Yeah. And you’re constantly buying low selling high or vice versa in the. Having a low cost index fund makes it easy just to not ever do anything.

because what are you gonna do? I think they come to this resignation, even in a bad market where, okay, I’m down 16% this year, but I’m still up 13% annually the last 10 years. But what, what am I gonna do? Am I gonna take my money out of this three- basis- point- total- market- fund and like chase somebody doing well this year?

Well, maybe, but I’ve seen over time that person’s gonna do bad. The next year. Screw it. And, and I, I think they just come to this like resignation of like, I got the best deal, no friction, I get to keep all my money. I own all the stocks I realize I don’t know the future and that’s it it’s over. And that’s how I think he won a lot of hearts and minds of investors and advisors.

But it’s only can be done if you have a cheap index fund. It’s way harder to be well behaved if you own some stocks. Single stocks. Or if you’re in an active mutual fund that might not be doing it. Maybe it’s down, worse in the market, then you start to panic. So I give him a lot of credit for helping behavior for a multitude of ways.

But, it is tough to behave because you’ve got the media sort of fans, the flames of like FOMO. Yeah. And like fear. And you feel like you should do something. And then also with commission free trading, it’s so easy to trade now. So there are definitely some things that you have to overcome to be a good behaved investor.

But he made it way easier and he brought a lot of attention to this concept as well. So I think the “art of doing nothing” is is it’s why I call it the art. It, it’s not, it’s not that easy. You have to really develop it, but he made it much easier. He deserves a lot of credit for helping behavior in my.

Bogle Effect in Europe?

Jacek Lempart: Right. I wanted to ask you also about the American ETFs and European ETFs, because most people in Europe don’t have access to us register ETFs for regulatory purposes in the European union. And I wanted, so for that reason, for example, Vanguard and also BlackRock State Street, they are opening, they are launching ETFs, registered in Europe. Do you think that Vanguard is able to. Do the same thing and do the same thing to competition, which it did in the US, but on the European ground. That for example, will really force the big players, especially the active mutual funds, in some countries, they have very, very high fees. Do you think that Vanguard can really go country by country and really beat them and, and. Make the Bogle effect in Europe, for example.

Eric Balchunas: That’s a great question. And I try to approach this in my book because it, it hasn’t taken off nearly as much in other countries. First of all, Bogle was here. So he was in the US himself.

There’s no real type Bogle characters out there. The other problem that I think you have in other countries is the system still is based on commissions to brokers. And the advisor feels their big value add is to pick active managers. In the US, the advisor, which controls 26 trillion, the advisors are now, they go to a fee based fee where they get a percentage of your assets that naturally inclines them to buy good stuff for you because now it’s coming outta their money too. And they are they are There’s less, less of those type advisors overseas. Ultimately when that spreads, it will definitely help the Vanguard movement in my opinion, because of that.

So that’s one reason. The other reason is, you know, people in the US have had to get a little more wise about what investing is because we have 401ks here. So they, the US kind of put retirement on us. So we have at least some sense of like what a fee is, what a fund is. We read about it a little bit.

Our 401k plans have this list of funds. We have to find out what they do. You don’t really have a ton of that in other countries. There’s more pensions. And so I think the retail investor, there is less wise to some of this than they are in the US. And that’s also a hurdle. But I think over time it will just, it will just happen.

It’s interesting that the difference between an active fund fee in the us to a Vanguard fund fee is about half that as in Europe. Right. And yet in Europe they’re less reactive to that. And I really have explored why. And it is part of this just culture of, I don’t care. The incentive system there, there’s a couple reasons and we explored it, but they really should be a little more alarmed.

So becuase we completely freaked out here in the us and the gap is way smaller. So I do think over time it will probably help. I think at the end of the money, at the end of the day like that chart, I told you about the beginning, you’d rather have $350,000 than 150,000. I mean, I mean, that’s pretty, it’s, that’s pretty universal.

So I think ultimately that will, that will happen. It’s gonna take a while. Yeah. And there are people who are Bogleish over there. They’re not quite, you know, as big as he was, he was a huge force, but there’s definitely little Bogle inspired people in other countries. And I think that’ll. Vanguard is was late going overseas as well.

So they, they were a little late to the game. So it’ll take a little while, but they’re having some decent, decent flows in Europe and, and Australia in particular. But yeah, I, I ultimately think Bogleism and low cost will ultimately sweep the whole world. I mean, it’s going to happen.

Jacek Lempart: That’s a good thing.

Eric Balchunas: It’s just too logical. It’s too good for the consumer to not happen. It just. It’s just going to take a while cause..

Jacek Lempart: I understand.

Eric Balchunas: It feels like you guys and other people are like where we were in the 90. It’s just a little delayed.

Jacek Lempart: That’s a very good news. So let’s hope that indeed Vanguard and others will, will continue that work.

Just, I have one of the last questions before we will quit today because. Some people in Europe, even if they have access to American ETFs, they are not really interested about them for tax reasons. Namely in Europe, we have so-called accumulating ETFs. So if the dividend is paying out the dividend, in fact, the dividend is automatically reinvested within a fund.

And for that reason, there is no tax. And especially in Belgium, for example, the, the dividends are, are taxed on the 30% level, which is a lot. So for that reason, people prefer to have this accumulating ETFs, which are not existing in United States because they’re every, I mean, each ETF is distributing that dividend.

Even if you put that it automatically is reinvested. Not reinvested within the, the fund. It just buys more units of that ETF. So do you think that in United States, the providers are even aware of that issue or they care about it, or they don’t care about the, the people from Europe because they know that that, that still, I mean, it’s limited access to, to, to the ETF. So they don’t

Eric Balchunas: Does that rule, like just does that rule, you just described, apply to mutual funds too?

Jacek Lempart: Because the mutual funds, if they pay out the dividend, they it’s within the fund and then there’s no tax.

Eric Balchunas: Ah, so the ETF… The dividend comes out and you have to get it. You can’t just reinvest it without getting taxed.

Jacek Lempart: You are taxed. If you get cash on your account, then you have to pay tax on it. I mean, there are countries in some some European countries where even if you don’t get the cash, you still have to pay the tax. But most of the countries, if you don’t get the cash, it’s reinvested within a fund and there’s no tax.

Eric Balchunas: Yeah, well that could definitely slow it down. I think in the. ETFs are E better for taxes than mutual funds. And that helped them. It wasn’t the only thing that helped them, but it was, I would say it’s a top three benefit. Yeah, no, I that’s definitely a hurdle too. It, I don’t know. It just seems like not right.

I feel like you should get taxed when you sell it at a, you know, that’s the idea of taxing it for something you didn’t do. It just seems like, yeah. Yeah. I dunno. That’s how mutual funds are here. You, you get taxed even if you just did nothing. And I think it’s interesting. Yeah, that could definitely slow it down.

Hopefully they’ll fix that. That seems like the rule that you get BlackRock and these big companies over there, I’m sure they’ll work with regulators to try to solve this.

Jacek Lempart: Yeah. Yeah. And by the way, you have another great book, the institutional ETF toolbox from 2016, which I read as well. Just a question. Are you going to update it? Maybe even extended by European market?

Eric Balchunas: It’s a good question. Yeah, I probably should. It still holds up. I, I put mostly fundamental things there that are evergreen, but yeah, there’s some ETFs that I, I talk about that have closed some new ones that have come. I probably need to have an update.

Yeah, that’s probably very possible by next project. Bookwise is to update that.

Jacek Lempart: It’s very interesting your perspective, because while you are working for Bloomberg, you have access to great data. You can present really nice statistics. It’s really interesting. Therefore, I think it would be really very interesting to have such book also for not only for American ETFs, but also for maybe European, Australian. I dunno. By the way, do we have any plans for other new books?

Eric Balchunas: Not right now. You know, I was just talking to a guy in, in my department about book writing and I was like… you know, you’re ready to write a book when it just gnaws at you and you feel like this thing should exist. The world needs this. And I felt that about my first two books.

I don’t feel like that about anything right now. So I don’t know is the answer. So until I feel that gnawing feeling like this has to get out of me. I will not write one because it’s painful and you need to see that in order to get through the pain and the, and the struggle of it, you really need to wanna say it.

And I don’t really feel like that right now. But I, it, something, you know, the, the time between my two books is about five years, right? So maybe in another couple years, something will just naturally come in, come out where I’m like, this needs to be a book. Then I’ll know.

By the

Jacek Lempart: way I heard that the boggle effect originally had 600 pages, I believe. And you reduced that by half ?

Eric Balchunas: Well, it was 500 and I got it down to 340. Yeah, my gut. It was 500 pages. I over… I like to overwrite and then, you know, edit and cut, and cut, and cut, and, you know, try to just make sure that I take all the fat out. So I worked with my editor to try to get it tighter.

But yeah, it was long. At first too long. I had a whole chapter I removed. I went over how like passive portfolio managers manage ETFs and mutual funds and how they do securities lending, which puts money back in the fund. I call it the game of basis points. And everybody I gave the book to in the early form said this is just a little too wonky and boring.

So I had to, I killed a whole chapter. It hurt but you know, I think it’s good to overdo it. Like when you read about good bands, they usually write 30 songs and they take the 10 best ones rather than just saying, oh, the 10 songs we wrote are obviously very good, because we’re such a good band. I just don’t have that kind of arrogance.

 I’m not, I don’t think I’m that great. So I want to write a bunch somewhere in there, some good stuff and somewhere in there is like boring stuff. And I think that. That’s my process anyway, but that topic was actually very interesting to me regarding tracking difference because actually, I know they prove that they can give you the stable, extra profits creating almost free ETFs.

Even if you pay something, actually the tracking difference is working for you because of that security lending, for example.

Yeah, this is a huge point like VTI. It basically has zero tracking difference it’s so in other words, the securities lending they’re able to do , they get a little, a little, a little fee from that and they put it back in the fund and it eats up those three basis points.

And I still stand by that being important, but for most people, the idea of like, explain to them that like, oh, you can pay, you’re actually paying zero instead of three. They’re already so happy at three. Yeah. It’s like, this is just getting into really niche areas. So the common person… it’s not a big deal to them, even though I find it exciting, but…

Jacek Lempart: me too.

Eric Balchunas: I think it’s just, yeah, I know. You know, and I flick at it in the book and in my first book, I go over tracking difference quite a bit, but it just didn’t play well here. And I had to listen to the people because I didn’t want, you know, at that point I was too subjective. I needed to really hear what they said.

And be like, okay. All right, I’ll let that go.

Jacek Lempart: Okay. Thank you very much for your time, Eric, and thank you for your great books. So what’s the best way to find you if someone would like to contact you on Twitter?

Eric Balchunas: Yeah, my DMs are open. So just go to @EricBalchaunas and you can just hit me up with the DM and I will, you know, some DMs are ridiculous. Like it’s people trying to sell you NFTs, but if it’s looks like a normal DM, I will reply.

Jacek Lempart: Sure. Okay. Thank you very much for your time.

Eric Balchunas: All right. Thank you very much. Great to be here.

Jacek Lempart: Yeah, thank you. Bye bye.

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