By Christopher M. Wright

NAME: John C. Bogle TITLE: Founder and former chairman of The Vanguard Group, the world's largest no-load mutual fund company. President of the Bogle Financial Markets Research Center AGE: 75 EXPERIENCE: John Bogle says he's in his third career. He worked at Wellington Management, a mutual fund company, from 1951 to 1974, becoming head of the firm in 1965. But he was dismissed in January 1974, a casualty of the market's 50 percent decline in the early 1970s. Bogle's second career began in September 1974 when he founded The Vanguard Group, the first mutual fund enterprise to be owned by and run for the benefit of its shareholders. Vanguard has grown to over $750 billion in assets and more than 10,000 employees. His innovations at Vanguard encompassed index equity funds, bond fund management, and no-load marketing. After a series of cardiac arrests beginning in 1960 and wearing a pacemaker for years, Bogle had a heart transplant in 1996. He relinquished his CEO duties but remained Vanguard's senior chairman. After an unsuccessful challenge to Vanguard's mandatory retirement age of 70 for directors, he left the Vanguard Board at the end of 1999. Now in his third career, Bogle is president of the Bogle Financial Markets Research Center, a Vanguard unit headquartered on the firm's campus in Valley Forge, Pa. Bogle has been awarded 11 honorary degrees, as well as the Woodrow Wilson Medal from Princeton University for distinguished achievement in the nation's service. In 1999, Fortune named him one of the four giants of finance of the 20th century, and in 2004, TIME named him a "hero and icon," among the 100 most powerful and influential persons in the world. His books include "Bogle on Mutual Funds" (1993), "Common Sense on Mutual Funds" (1999), "John Bogle on Investing—The First 50 Years" (2001), and "Character Counts" (2002). His fifth book, on "owners' capitalism," is due to be published by Yale University Press in 2005. He enjoys hiking, biking, sailing and squash, as well as history. He serves as chairman of the National Constitution Center, on Philadelphia's Independence Mall.

Investment legend John Bogle pioneered no-load and index mutual funds while heading up The Vanguard Group. His views on investing and mutual fund governance, majestic in their simplicity, have remained remarkably consistent since he first expressed them in his undergraduate thesis at Princeton in 1951. Portfolio recently sat down with Bogle, who says he is now on his third career, and got his big picture insights on investing, the state of the mutual fund industry and how sector investing, including REITs, fit into his overall thinking.

Portfolio: Has the mutual fund scandal been resolved to your satisfaction?
Bogle: We're making wonderful progress, thanks to the SEC and its chairman, William Donaldson. Independent board chairmen have been mandated for mutual funds. Fund manager boards must have a supermajority of independent directors—75 percent. And the SEC has authorized the hiring of staff and the retention of independent experts to provide board members with objective information so they no longer have to rely solely on what management puts in front of them.

Portfolio: What's left to be done?
Bogle: The preamble to the Investment Company Act of 1940 states the ideal that investment companies should be "organized, operated, and managed" in the interest of shareholders rather than in the interest of managers and distributors. But it's very clear that's not how the industry operates. An express fiduciary duty standard for fund managers and distributors to act in the interest of shareholders needs to be written into the law.

Also, it's a disappointment that fund executives are not required to disclose their compensation. Right now, all they have to disclose is the method by which they are compensated. But there's nothing like full disclosure of the numbers to alter conduct. A $37 million compensation figure tends to catch the eye. It's an act of hypocrisy to fight such disclosure while demanding it on the part of corporations whose shares the funds own. In effect, the mutual fund industry is saying, "you tell us your compensation but we won't tell you ours."

Portfolio: Why do you continue to criticize the mutual fund industry with respect to sales loads, fees, marketing expenses, turnover and taxes?
Bogle: Because all of these costs are still too darn high. Gross return minus cost equals an investor's net return. There can be no doubt about what I call the "CMH"—the Cost-Matters Hypothesis. The evidence shows that over the past 20 years, the average equity mutual fund has underperformed the stock market itself by about 3 percent per year—just about equal to their fees, expenses, sales charges and transaction costs—and that an amazing 85 percent of actively managed equity funds underperformed the broad market index in that period. I'll keep right on criticizing the industry until costs come down to reasonable levels.

Portfolio: Has Vanguard succeeded in its mission to be the lowest cost provider of financial services in the world?
Bogle: I try to avoid using the word "success." In business, success is a journey, not a destination. The journey is never over, but I would say we have accomplished the mission. Vanguard's average expense ratio is 0.25 percent, versus an average of 1.25 percent at other mutual fund companies. No one can come close to our expense ratio. That 1 percent savings, on a $750 billion asset level, means that an extra $7.5 billion a year is being returned to Vanguard's shareholders. That's real grown-up money.

Portfolio: What safeguards are in place to ensure that Vanguard will continue to be controlled by its own shareholders and run for their benefit?
Bogle: There is no guarantee that Vanguard will continue to be run in the present mode forever. Structures can be changed. But I'm confident that our directors and shareholders would never let that happen. If they were foolish enough to abandon the existing structure, I would turn over in my grave.

Portfolio: What you say reminds me of Arthur Andersen, who started his accounting firm in response to some early scandals in the accounting industry. It's ironic that his firm blew up in the Enron scandal some decades later.
Bogle: It was said at his funeral that he would rather the firm die than have its principles compromised and, of course, it finally did both. Anything can happen. Look at life insurance companies. They were all mutual companies 25 years ago but have since become public stock companies, largely as a way to enrich their executives. If I may quote the Good Book, they "sold their birthright for a mess of pottage."

Portfolio: You've criticized companies for smoothing and managing quarterly earnings and analysts for preferring that practice to reality. What would it take to change things?
Bogle: The focus on engineered quarterly earnings statements reflects a switch in the orientation of institutional investors—away from long-term investing and toward short-term speculation. This has caused other problems in addition to managing earnings.

It used to be that mutual fund turnover averaged 15 percent a year. That worked out to a seven-year holding period. Turnover is now greater than 100 percent and the holding period has been reduced to 11 months. Mutual funds have become a rent-a-stock industry, and, partly as a result, have abandoned any notion of corporate citizenship. Eleven months is simply too short to care about corporate governance. So the mutual fund industry must accept a share of the blame for recent governance lapses and scandals in corporate America.

What we really need is a complete sea-change in the way institutions invest in this country—a return to long-term investing. We also need the mutual fund industry to return to its activist roots and take up the cause of shareholder rights once again.

I'd help things along with a tax on short-term transactions, assessed on taxable and tax-free investors alike. Today's long-term investors are largely index funds, and for the past three years I've been encouraging them to take up governance matters.

Portfolio: Do you have a view on REITs as an investment proposition?
Bogle: People should invest in total market stock and bond funds for the long term. Total market indexing is the gold standard. Anything else, like sector investing, is a dilution of that standard. When you pick sectors, you might be right or you might be wrong. Emotions take over. People tend to get into a sector after the good returns have already happened. It's the rowboat syndrome—investors look backwards, buying after the sector has done well and selling after the sector has done poorly.

Sector timing is difficult to the point of impossibility for an investor to do successfully. There's no known way to select a sector that will outperform on a long-term sustained basis. While REITs did 1 percent better per year than the S&P 500 during the 10 years from 1994 to 2003, in the 10-year period from 1988 to 1997 they performed worse and had higher (annual) volatility.

Portfolio: Total market stock and bond funds are the bulk of your personal portfolio.
Bogle: Yes.

Portfolio: You're still a total market investor despite the incredible run-up in the tech sector prior to March 2000 and the fact that REITs and other sectors have outperformed the market since then. Sector investing still doesn't impress you, even though the total market has been mostly down in the last few years. Come to think of it, not even losing your first job in the market decline of the 1970s shook your faith in total market investing.
Bogle: That's right. But I control risk by way of my bond market exposure—about 70 percent of my assets during recent years. As a result, I've done well, not only over the long-term, but also during the tough years since 1999.

My argument about sector funds isn't about REITs, per se. I could see an investor owning the Vanguard REIT fund, but I don't think they should make it more than 10 percent of his or her portfolio. No one should get overexposed to any one sector, and I'd be especially cautious when that sector is hot. My advice about indexing runs counter to those who are trying to build an investment advisory business. When their clients realize that total market indexing is best in the long run, it won't be long before they start asking, "What do I need you for?"

Portfolio: Speaking of people waking up, why do you suppose it is that people still buy most mutual funds when, as you have said, they cost too much and underperform?
Bogle: It's "the triumph of hope over experience," to quote Dr. Samuel Johnson. "Hope springs eternal in the human breast," as Alexander Pope said. No amount of evidence, it seems, can destroy that deeply ingrained part of the human psyche.

Portfolio: What are the biggest changes you've seen in 50 years of investing? Is anything being lost that is worth preserving?
Bogle: The most important single thing that's been lost is the notion of long-term investing. Three billion shares change hands every day. It didn't used to be like that.

Portfolio: Have any positive developments during your career made things better for investors?
Bogle: That's such a great question. Under pressure, mutual fund sales charges have in fact come down–from 7 percent or 8 percent in the 1950s and 1960s to 3 percent to 5 percent today. However, that reduction gets obfuscated by the games funds play with A, B, and C share classes—what I call "alphabet soup" shares.

Also, there's infinitely more information about the mutual fund industry available now. There are many articles in the press. And Morningstar is a wonderful service. It arms investors with all the information they need. With all the data available, however, it's too bad that people focus largely on recent performance. When they use the wrong information, they make the wrong decisions. "With all thy getting, get wisdom," as the saying goes.

The market is more liquid now and there are an infinite variety of mutual funds out there, but to what avail? What we need is a healthy dose of long-term investing.

Portfolio: As you look ahead, are you hopeful or pessimistic and why?
Bogle: I'm an eternal optimist. I always have been. I'm an idealist. Mankind will move in the direction of what's better, not worse. Right after September 11, the front page of The Times of London carried a photo of the remaining shards of the Twin Towers with the headline "Good Will Triumph Over Evil" written underneath. I had it framed and put it right outside my office.

Information is getting out about the high cost of mutual funds and the folly of dreamed-up sector funds. There's not a scintilla of evidence that active managers do better than indexing which is now one-sixth of all equity fund assets. That's truly remarkable growth. Things are moving in the right direction. Investors may ignore their own economic self-interest for my lifetime, or even yours, but they won't ignore their own economic interests forever.

I'm also optimistic we'll get an improvement in fund governance. We're making progress on putting the interests of shareholders first. In 10 or 20 years, this industry will be a much better place for investors to entrust their hard-earned savings.

Portfolio: What was it like for you personally to be a low-cost distributor? Did you take abuse or personal slights from others in the industry?
Bogle: I know a lot of people don't like my message but I'm too busy to notice what they say about me. But I'll tell you one story. A few years ago, I was in the audience at a meeting of the Investment Company Institute (ICI) when the speaker, an industry leader, named Vanguard and Bogle as the forces that were most hurting the industry. He said, "the problem with Bogle is not that he's a communist, he's a Bolshevik." I went up to him afterwards, smiled, shook his hand, and said, "I really appreciate the compliment. Around the office, they call me a fascist."

It's only a slight exaggeration when I say that at recent ICI meetings, most people who've been in the business 25 years or more don't even make eye contact with me. But the younger people, with unbelievable frequency, tell me that I'm their hero, and that they wish their firm could be more like Vanguard.

Portfolio: You have some things in common with Bill McGowan, the man who founded MCI and started the low-cost revolution in the long-distance business. He was a low-cost distributor, a visionary, and, like you, he had a heart transplant.
Bogle: I met him once in Washington after his transplant. This was long before I started thinking about one for myself. Contrary to what you might have heard, not all revolutionaries need heart transplants. Not much changed for me after my operation in 1996. I want to build a better financial America. Making our nation's values felt abroad depends on a strong capitalistic system that builds strong economic power. I want to leave things better than I found them.

But we're all sinners and I'm still the same flawed human being I always have been—the same old Bogle. But my career has been an unalloyed joy. I don't worry about the future. Nothing keeps me awake at night. There's no way other mutual fund firms can compete with Vanguard on price, and therefore on long-term performance.

Portfolio: You're 75 now, an age when most people are retired. But you're on the road, giving as many as four speeches in a day, speaking out on important issues like corporate governance and mutual fund reforms. What keeps you working? What gets you out of bed in the morning?
Bogle: The joy of living another day. Seeing the sun rise and set. The joy of contributing to society. The joy of my family. What means more to me than all the accolades, all the awards, and all the honorary degrees bestowed upon me, are the letters I get from individual shareholders expressing their appreciation. They followed my advice. They got their fair share of the markets' returns. They are absolutely convinced that their lives are better for what we've done for them. I get letters like that about every day. If that thrill doesn't get you out of bed in the morning, then you're a sad piece of work.