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Vanguard's John Bogle: Financial Industry Puts Investors Last

Wall Street costs too much. "It's an extractive industry", says Vanguard founder John Bogle. "The investor feeds at the bottom of what is now the tremendously costly food chain of investing."

In his new book, "Enough: True Measures of Money, Business, and Life," he cites what might be an investment banker's view of the national economic crisis: "The bad news is that we lost a ton of money. The good news is that none of it was ours."

For all of his professional life, Bogle has crusaded against the enormous fees the financial industry charges for investments. "It's not only the largest sector of our economy, it is also the only industry in which customers don't come anywhere near getting what they pay for," he said in an interview. "On balance, the financial system subtracts value from society."

Banks, insurance companies, brokerage firms, and mutual fund companies all are sophisticated profit maximizers, as you'd expect in a capitalist system. Their job is to look after shareholders, not to look after you.

"They have a large incentive to favor the complex and the costly over the simple and cheap, quite the opposite of what most investors need and ought to want," Bogle says.

Your job, as a customer, is to let them extract as little from your wallet as possible. That means putting "low cost" at the top of your requirements. The less you pay for your investments, the more likely you'll accumulate enough money to retire on, not to mention maintain your standard of living after retirement.

Bogle illustrates his point with the world he knows best: mutual funds. Vanguard's largest index fund -- the 500 Index Fund, which tracks Standard & Poor's index of 500 leading stocks -- costs 0.18 percent a year and earned 12.3 percent annually over the 25 years ending in 2005. The average equity fund, run by active money managers, costs 1.5 percent (not counting the transaction costs of their heavy trading) and reported 10 percent annual returns, he says.

The industry today has more in common with the fashion business than with traditional, long-term investing. Are tech stocks selling? New tech funds pour into the market. Are you scared of stocks? New types of costly, "no-lose" investments proliferate. It's a classic sales strategy: "If the man wants a blue suit, turn on the blue light."

The lure of fashion diminishes your returns. In the 25 years that the average equity fund was posting 10 percent, investors in those funds earned only 7.5 percent. That's because they hopped from fund to fund, buying into high performers just in time to catch their cycle down. Restlessness, like costs, can demolish your investment dreams.

"Mutual funds today are born to die," Bogle says. In the 1950s, 13 percent failed. In the most recent decade, the failure rate reached almost 60 percent. Each decade's fashionable losers are typically wrapped into other funds, and their dismal records expunged.

Investors fall for these games because they're lost in market illusions, Bogle says. They're moved by daily prices, but "the value of America doesn't drop 3 percent in a day because the stock market does. The market is a giant distraction to the business of investing."

Over the long term, stock prices reflect the growth of corporate earnings plus dividends. Speculation adds or subtracts a little, during short time periods, but doesn't change that basic measure of value.

Corporate earnings grow with the economy -- an average of 4.5 percent, also over the long run. Add 2.5 percent in dividends today and you're looking at 6.5 percent for stocks, not the historical 9 percent that savers might be hoping for.

"That's the reality," Bogle says, which makes it even more important to hold down costs. The three fund groups with the lowest costs are Vanguard, TIAA-CREF, and Dimensional Fund Advisors, which is purchased through investment advisers.

In "Enough," Bogle isn't interested only in better investing. He's moved by morals, which he finds sorely lacking in business and finance today. The 18th Century economist Adam Smith, author of "Wealth of Nations," is famous for his theory of the "invisible hand" -- the idea that, while serving your self-interest, you're unintentionally promoting the interests of society, too.

Capitalists who quote that view to justify any predation forget about Smith's earlier book, "Theory of Moral Sentiments," Bogle says. There, Smith presented his views in a different light. "When we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration," he wrote. He urged readers to admire "the propriety of reining in the greatest interests of our own for the yet greater interests of others ... in order to obtain the greatest benefit to ourselves."

We've been forgetting about the "others," Bogle says.

Not surprisingly, his wrathful views win him no popularity in the mutual fund industry. In fact, "if you had an unpopularity contest, I would come in first," he says, "and I don't know who would come in second. But in a popularity contest among investors, I'd come in first."

More on MoneyWatch:
Investment Fees - Investors Send Strong Message to Wall Street
Uncommon Sense: An Interview With John C. Bogle
John C. Bogle on the S&P 500 vs. the Total Stock Market

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