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Vanguard founder blasts funds' short-term focus

Published Sep. 27, 2005

Vanguard Group founder John C. Bogle has been a thorn in the mutual-fund industry's side for three decades, and he's not finished yet.

Four years ago, he had a heart transplant. Last year, he lost an all-too-public battle to remain a Vanguard director beyond the board's mandatory retirement age of 70. Last week, Bogle turned 71.

Slow down? Not a chance. Bogle has set up shop as president of the Bogle Financial Markets Research Center, which is funded by Vanguard. From his new perch, he is setting his sights on the increasingly short-term focus of fund investors and fund companies. Only Monday, he was outlining his concerns in a fiery speech to a New York conference organized by the Practising Law Institute.

Bogle argues that fund investors and fund managers trade too much, that fund companies charge too much and that the fund industry is bringing out too many untested funds. "This all adds up to a complete abandonment of the core mutual-fund ideas, which are to diversify and hold for the long term," he says.

Bogle hasn't always been on the winning side of arguments. In the early 1990s, for instance, he predicted modest stock-market returns for the decade ahead and was proved badly wrong.

Still, Jack Bogle usually is right. He has long argued that investors should stack the odds in their favor by sticking with no-load funds with low annual expenses. More recently, he has emphasized the importance of further cutting your investment costs by favoring tax-efficient funds. As part of this emphasis on cost, Bogle was an early proponent of market-tracking index funds. (He isn't so keen on the stock exchange-listed index funds that Vanguard is about to launch, however, because he fears investors will trade the funds too much.)

So what's got Bogle bristling these days? Here's the lowdown on his four most recent complaints:

In the 1960s, investors sold some 7 percent of their stock-fund holdings each year, suggesting a typical holding period of 14 years. Last year, that number reached 40 percent, which means investors are holding their stock funds for an average of just 30 months.

"To some degree, it's performance chasing," Bogle says. He lays part of the blame on fund advertising, which has increasingly emphasized spectacular short-term returns.

Even if investors wanted to stick with their stock funds for the long haul, many couldn't. In the 1990s, more than 5 percent of funds were closed or merged out of existence each year, compared with a 2 percent annual disappearance rate in the 1980s.

"The idea that half the funds go out of business in the course of the decade is astonishing to me," Bogle says. "In some cases, it was because the manager didn't measure up. But in other cases, it was because the funds were focused on industries or concepts that proved invalid."

Bogle predicts that in the decade ahead, many of the now-popular Internet funds also will be shuttered.

Until the mid-1960s, stock-fund managers bought and sold about 15 percent of their portfolios each year, implying a holding period of close to seven years. Since then, managers have become ever more trigger happy, with turnover today running at 90 percent, which means managers are hanging onto their stocks for just over a year.

"High turnover means high trading costs," Bogle says. "And high turnover means high taxes."

The average annual expenses charged by stock funds has doubled in the past 40 years and increased 65 percent over the past 20 years, reaching 1.58 percent last year. True, investors tend to favor funds with lower expenses. But even the cheapest 10 percent of funds have become more costly, with expenses rising 27 percent since 1980.

Consider large-company stocks funds, which can be reasonably compared with Standard & Poor's 500-stock index funds. Because of trading costs, taxes, annual expenses and the drag of holding cash, large-cap funds generated an annual after-tax return of 12.2 percent over the past 15 years, compared with 16.7 percent for an S&P 500-index fund.

That laggardly performance may not seem terrible _ until you look at the long-term impact. Over the course of the 15 years, if you were invested in the average fund, you would have accumulated just 55 percent of what you amassed with an S&P 500-index fund.

Of course, for each of Bogle's complaints, you can come up with a reasonable response. Fund investors and fund managers may be trading more because that's what today's fast-moving markets seem to demand. When fund companies open and close funds, they are simply responding to the ebb and flow of investor interest. Annual expenses may be higher, but investors now pay lower fund sales commissions and get better service from fund companies.

Placated? You shouldn't be. Holding down costs, minimizing taxes and investing for the long haul are core investment principles. If your fund managers aren't concerned about such things, maybe it's time to find some new funds.

_ Jonathan Clements writes for the Wall Street Journal.