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April 13, 2023
Episode 71 of the NewRetirement podcast is an interview with Eric Balchunas — a senior ETF analyst and funds product specialist at Bloomberg and author of The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions. Steve and Eric discuss the book, ETFs, and the future of financial advice..
Steve: Welcome to The NewRetirement Podcast. Today, we’re going to be talking with Eric Balchunas, the Bloomberg senior ETF analyst and funds product specialist. We met at the Bogleheads Conference. He is joining us from Center City Philadelphia. We’re going to discuss Eric’s book, the Bogle Effect, also the Wealth Universe, ETFs, and the Future of Advice. So with that, Eric, welcome to our show. It’s great to have you join us.
Eric: Great to be here.
Steve: No, I appreciate your time. It was great hearing your talk at the Bogleheads Conference. I was really impressed with the insights you had about Jack Bogle and the story about Vanguard, and how I created it, and the influence on the overall market. Before we dive into that side, I would love to get your take on how you got started in the investing world, and what drove your interest in this space.
Eric: I went to Rutgers, and I was enrolled in the School of Sciences. I didn’t know what I wanted to do to be honest. I went to Chemistry 101. I got through biology, went to Chemistry 101, saw the syllabus, and I walked out. I was just like… I just can’t see a life in the science like this, and I respect anybody in that field. It’s really takes a lot of hard work and brains to be there, but it wasn’t for me. I just needed something that was a little more exciting and simple to comprehend, I guess. So, I ended up writing for the school newspaper, the Rutgers Targum, the Daily Targum it’s called, and I love that.
I loved writing articles. At the same time, I took an ECon 101 class, and that clicked, macro and microeconomics. It was… It showed me how everything worked, and it just made sense more than the sciences did. I was like, “Okay, I’ll do journalism and communications, and I’ll minor in environmental economics.” I did, and then I applied to Bloomberg right out of college. I was like, “That’s the perfect place for me,” but I got rejected. So, I ended up working at Institutional Investor as a reporter. I covered mutual funds there. That’s important later. Then two years there, then I worked at a PR firm, because I met a PR guy.
I was like, “This is a cool job. You’re closer to the real truth,” and so I did that for a while at a crisis communications firm. Funny story there, one of our clients was Long-Term Capital Management. So, I got to do the media trading for John Maryweather and a couple other guys. They were not happy when we did it. They were polite but very serious, and that was interesting. That was a pivot point for me, because that’s a classic case of how hard active is, because these guys were all PhDs and the best of the best, and they went… They couldn’t do it. They had problems.
Anyway, so then I went from PR. I got a job offer from a head hunter for… She came to the two jobs. That’s how good the economy was in the ’90s. A 26-year-old would get headhunted. She got PR jobs at two places, Bear Stearns and Bloomberg. Thank God I had the brains at the time to go, “Oh, Bloomberg, of course, I had…” I told her I tried to get in before, and I’d been to the office once, and it was a cool office. Anyway, so I get a job at Bloomberg, did that for a couple years, then went to data, because I’d moved back to Philly, so they have a data office in New Jersey.
I did data for 12, 13 years, and then having been a communicator, I got ETFs as a coverage area in Bloomberg data in 2006-ish. I was like, “Holy moly, these things are going to be the future.” I knew mutual fund, so when I saw the ETF, and I kicked the tires on it, I’m like, “This thing’s like six evolutionary steps beyond the mutual fund. I’m going to basically gamble my whole career on this thing.” So, I became the in-house ETF expert. Then when Bloomberg started a research department, the head of research had seen me do some TV spots, or talk about it, so he’d start to come to me asking me for what ETF to use for a certain trade, probably for his personal account.
Then he hired me, and so I was hired to lead up the ETF research for Bloomberg Intelligence, which I’ve been doing for six years. So, those… I like to tell people, “My job now takes all three of those career paths into play reporting, news idea and sources.” They’re very good data and PR. Nowadays, if you are a writer or any content creator, you’ve got to market yourself and your stuff. It’s so much content. I am happy I had that skill. Now, I am able to use all of those experience points in my current job.
Steve: That’s awesome. It’s funny that you worked on Long-Term Capital Management. I met Bob Burton. He’s actually been on this podcast, so I think that’s probably the low point of his career. But otherwise, he’s won the Nobel Prize, and we think a lot alike about the focus for retirement being around income versus assets or needs to be much more on income versus assets.
Eric: Yes, just funny sidebar there as well, there’s a guy who worked at Long-term, Victor Haghani. I think I might have… His last name’s close to that, smart guy. He now runs a small advisor for mostly family and friends, but it’s all low-cost ETFs. I interviewed him for my last book, and because I read an article in the journal about this guy’s road from active manager to low-cost ETF guy. I thought that was interesting, but he had… That experience, even though it didn’t go well, had to have been pretty exciting to work there.
Steve: No, it was a moment in time. I think at the point, it was one of those moments where they’re like, “Oh, you could break the financial system. You’ve put so much leverage on.” Then they pull everyone together into one big meeting overnight, and they’re like, “Hey, we need to make sure that everything’s going to keep running in the morning.” Anyway, one of many financial crisis that we have lived through, and we’ll probably continue to see. I actually had… I was doing a podcast with Burton Malkiel yesterday, and so he’s for the 50th anniversary of his book, Random Walk Down Wall Street.
It’s just interesting hearing his side of the world. I mean, I actually met… Well, I saw him on video, met you in person at the Bogleheads conference, but you can get a pretty interesting perspective hearing from someone who’s… I mean, he’s 90 years old, right? So, he’s seen a lot.
Eric: No doubt. He’s really great. I also interviewed him for my book, and he had some really great stories about Bogle, but also just generally speaking, he’s just a really big advocate for passive. I asked a couple of people this question in my book, which is how big could passive get before the market stop working, because that’s something people are worried about? He was probably the most aggressive in how big it is. I think he said 95%. Right now, it’s maybe 30. So, we got a long way to go before we hit his limit, although others were a little more… Their bar was a little lower, but most people were over 80.
Steve: I think… What are we at now? 50% or something like that?
Eric: Well, so it’s 50% of funds are passive, but funds only own 40% of the stock market. We like to say that passive is about 20% via funds, but probably, you add 10 more percent for institutions. Then you get to 30%-ish, maybe 35, of public stocks that are run by passive funds or passive strategies.
Steve: Well, it’ll be interesting to see if we had to… what happens if we move towards 50%, 80%, 90%.
Eric: It’s an interesting question. The one thing… I’m a sniff test guy. Does something feel right, look right? If a company has bad earnings, the stock goes right down. Stocks are moving in the fed height, so stocks as a whole went down. Some stocks went down more. Those high-flying stocks went down more. If passive controlled everything, you wouldn’t see these natural moves that are completely correlated to the news and the new data available. So, until I see stocks not moving, I’m just not going to worry about it. I think the one thing that passive is going to bring about is slightly more volatility, because if you have more people just doing nothing, then that means there’s just less people trading, which means the stocks could move a little more.
But if you’re active, you should embrace that, so I think we’ll probably see a little more vol, especially on the smaller, mid, and small caps. You might have the possibility to hijack a stock the way the Reddit crowd was able to control GameStop. It’s possible that some of the smaller names, because passive owned so much, you could get together, and actually really control some of the shares. Like I said, these are very, very one-off cases, but you won’t be able to do that with Apple, but maybe on some small stocks. So, we’re watching it, but again, things seem to be moving fine, and I think it’s overblown of a worry.
Steve: Eric, if you could give us… Before we jump into the wealth universe part of this, if you could give us a few minutes on the story of ETFs, why they got it created, how they’re evolving vis-a-vis mutual funds, where you see them going, I think that’d be really helpful for our audience.
Eric: Sure. I’ll do as brief as I can here, just give you the bare bones. The ETF, for those people who don’t know much about them, I think the best description I’ve heard is it’s a mutual fund with benefits. It’s structured the same. It’s the same regulations that govern mutual funds and ETFs. So, these are SEC approved ready for primetime structures. I believe in the structure. I’ve dedicated my career to it. It’s been through several tests, and so it works really well. The reason it works well, and the reason it was many evolutionary steps ahead of it was the design.
I’ll take you back to the guy who invented the ETF is named Nate Most. He worked with this guy Steve Bloom at the American Stock Exchange in the ’80s. After the crash of 87, there was a lot of people who were scared of futures and derivatives to hedge. A long story short, it was called portfolio insurance, and it totally didn’t work. Anyway, so people were not really feeling futures, but they liked to trade things easily. So, these guys were like, “Our exchange is in third place. We need to get volume up,” and so they had this idea, “Let’s have a mutual fund that trades, and it’ll be… We’ll physically have the assets stored,” so there’s no chance that you get none of your money back.
You’ll have the actual assets stored like a mutual fund. So, they went through a few iterations of this, but they really created a genuinely good innovative product is when Nate Most worked at the Pacific Commodities Exchange. In a commodities exchange, you would take in a bunch of soybean oil, let’s say. You don’t want to trade actual physical soybean oil back and forth. It’s a pain, so you go to this warehouse. You put it in the locker. They give you a receipt, and you can trade receipts all day long for the commodity stored in the warehouse. Much easier, right?
If you get a bunch of receipts for soybean oil, and you want yours back, you just go to the warehouse, and they give you the proportional soybean oil, and you’re on your way. He applied this to stocks, bonds, everything at this point, although it indicate the S&P 500 stocks. That’s why the first ETF is called SPDR, S&P Depository Receipts. So in order to create shares of SPDR or SPY, you take in the 500 stocks in the exact waiting. It’s like a recipe. You hand those into State Street. They give you 50,000 shares of SPY. Those receipts then trade all over, and if there’s a lot of demand for more, somebody’s going to go and deliver more of the stocks, get more SPY receipts.
If people are all selling, you’re going to see them trade in the SPY receipts for the actual shares back. That’s called the creation redemption process. Through that process, you’re able to manage taxation better because no money is exchanging here. That’s called in-kind. That right there, I won’t go into any more detail, but that’s the… If you’ve seen Back to the Future, that’s the flux capacitor of the ETF. It’s what makes ETF so magical, and they work so well is that process. That employs market makers and authorized participants. It’s like…
That’s going on underneath, so that your ETF sits there, and it trades nicely, attracts the NAV. Because you can do that, if the ETF gets anywhere outside of where NAV is or the underlying value, someone’s going to that, because you could just sell the ETF, and buy the underlying or vice versa. That’s why ETFs work so well, and they are durable, and that’s why they’re tax efficient. Anyway, that’s the story, and when I tell the commodities warehouse, it gives people a visual. It’s just not a warehouse. It’s called a custodian, but it’s the same concept.
Steve: Got it. So, versus a mutual fund, where they only transacts once a day, end of day after whatever, after the market’s closed, they’re essentially moving the positions around?
Eric: A mutual fund’s fund’s almost even more simple to understand. It’s just, “Hey, I’ve got this fund. We’re going to pull our assets together, and I’m going to tell you what the NAV is every day. You’re going to buy the fund through me.” The issue with the mutual fund, and the reason ETFs have taken off, especially in taxable accounts, is that in a mutual fund, if you are a big investor, and you want to get out, I have to sell stock or bonds to cash you out. That creates a tax event, and so that’s why every year, the people who do nothing but are loyal and stay there get hit with the capital gains distributions, and people find that annoying.
I think the ETF is fair. The mutual fund is treated unfairly. I feel like it’s not that the ETF’s a tax loophole. I feel like the mutual fund should be lifted up to that level. I feel bad for mutual funds. By the way, that tax efficiency of the ETF, they didn’t design it for the tax. It was a happy accident, but the mutual fund I think is… The way they do it is unfair, so the ETF is really… I would put that tax efficiency is one of the big three advantages of the ETF along with the low fees and the intraday liquidity.
Steve: It’s great to get this history. I mean, I’ve obviously seen the emergence of these things. When I started my career in financial services, it was all mutual funds, and ETFs emerged. I was like, “Okay, cool. Trade in today.” Didn’t appreciate how they came to be created. All right, well, let’s shift gears to… I want to talk about… One thing you brought up is like the wealth universe, and this is something that’s interesting to me in our audience. How is wealth distributed and concentrated in this country, and what that means for our society? Then that’s going to lead us into a little bit of a discussion around the advisory business, and then we’ll dive into your book.
I know there’s a lot of topics, but we can sift through some of this stuff, but I would love to get your take on how you see the wealth universe and it evolving.
Eric: I mean, I put things into three buckets, which is institutions like asset owners, pensions, endowments, family offices, advisors or wealth managers, and then just regular people with their own money doing it themselves. I mean, I know probably… You had that number. You told me in our prep call of about 100 trillion, and that sounds right to me. I know advisors manage about 26 trillion. Institutions, I would want to say, are 40, and then maybe the leftover’s retail, something like that, but I could be missing a whole chunk or part of the wealth universe.
The other part of that question that makes me… that I could have a intelligent comment on also is when you think of wealth in America, there’s obviously a huge wealth gap. A big reason for that is that the wealthy people own stocks more so than people who aren’t wealthy. 50% of Americans don’t own any… aren’t exposed to any stock or the bonds or anything, and so the stock market has, I think, been exacerbated the wealth gap. The top 1%, I think, own 50% of the stock market. So, there is a lot of really rich people in the stock market as well, but I don’t know if I’ve just jumbled things too much there.
Steve: No, that’s super helpful. Actually, I was… We report on the fact that the number we have is $108 trillion of total wealth in this country. It’s about 75% controlled by the 50 million households that are over 50. So, one big slice is just there’s a lot of wealth concentration with boomers and older folks. In fact, when I was researching, it’s like they have nine times the amount of wealth as millennials. It’s crazy.
Eric: I think boomers own 83% or 90% of the stock market. It’s some crazy number, which by the way is why when you talk about ETFs and looking forward, most of the boomers own it through mutual funds, or a lot of them do. That was their vehicle of choice. As they pull out, and use their money for retirement, or pass it on to their kids, you’re going to see this huge demographic tailwind moving more money into the ETF structure.
Steve: 100%, and I do want to talk about that in a second, but no, the numbers are pretty surprising. I mean, the top 1% owns 30% of all wealth. The top 10% owns 75% of it, so two through nine owns another 40%, and then 10 through 50 owns 30% of the wealth, and then the bottom 50 owns 1% to 2%. It’s crazy how little money the bottom half of this country has.
Eric: It is. I just spent obviously two years studying Bogle. He did wonders for the 50% that hold stocks and bonds. He cleaned that area up big time, but even in his book, he talked about the other 50 and said, “If we don’t address that, there’s going to be major problems. You’re going to have real issues in America if we don’t figure out some more… We don’t close that gap in some way.
Steve: 100%. Since we’re on the topic, I’ll reel off some of their stats that I have, which is interesting. 33% of money is held in retirement accounts. 29% is in home equity. So, home equity is the other big chunk that I think a lot of people don’t talk about, but for many households, it’s half the wealth that they have. Then for a big chunk that don’t have any investments in the stock market, it’s probably the vast majority of their money. 10% is in stocks and mutual funds, 9% in other things like banks and insurance, 6% in business, 5% in rental properties, 4% other real estate anyway, then vehicles.
It gets smaller and hard, but it’s interesting looking at that breakdown. Let’s jump into the advisory business. I would love your take on… We talked about that wealth concentration, and that is going to get transferred. One of the things we’ve talked about is I think it’s $35 to $40 trillion is going to move from one generation to the next in the next 10, 20 years. How does that affect the advisory business?
Eric: I think a lot of advisors are thinking about this. In fact, the Ritholtz company just had a conference in California called Future Proof. That tells you all you need to know. They’re getting together to see how can they prepare themselves, so they don’t get blindsided in the future by this change or fees or anything. I think it’s smart. They really should be looking ahead, and creating as much value as possible. So, my take on the advisory world is they’re where mutual funds were in the ’90s. They largely charge 1% or 75 basis points, and they do your portfolio and, if you’re lucky, some other things.
I think that’s probably too much for that service. I think you have betterment really showed that. Vanguard and Schwab now have advisory services with the charge of less than 30 basis points, and they’ll do a lot of those other things. I think what you’re going to find is advisors who don’t hustle and give you a lot of value, and charge 1%, they’re going to go out of business. So, we have two choices. You either lower your fees, and be the low-cost service. Go to hourly rate or flat fee. I’d called all those the Bogle-esque people.
The other way is just to build value as much as possible. So, you charge 1%. Well, we do so much for you, estate planning. We’re a psychologist. You want a… It’s high touch kind of thing. I think that’s fair, and I think the market will sort this out. If somebody’s really wealthy, and they feel like their advisor is just really important to their peace of mind, they’ll pay the 1%, or an advisor might be really good at one thing, and people are going to go to that advisor for that specialty. I heard somebody who’s talking about there’s one… There’s an advisor who’s real big with bass fisherman.
So, if you can find a little niche, where you’re the man amongst these certain group of people, and they all share word of mouth, and you become part of their culture. I think you can also hang onto those higher fees there. I think you need something else if you’re going to charge 1%. Otherwise, I think there’s going to be a cost pressure. Just like is happening and has happened in the funds world, it’s coming to the advisor world.
Steve: I agree. I mean, the CEO of Vanguard was saying he wants to… They launched personal advisory service. They wanted to bring that fee pressure that they brought to mutual funds to wealth, but we’ll see. I mean, if you look at the data, advisors have done a good job of protecting their margin, but they are having to do more. I definitely hear flat fee fee only planning also that for sure not just it’s gone… Asset management has gotten commoditized, so you have to do estate planning. You have to do tax planning, and many folks are now getting a tax prep.
Then, I mean, I think if you look at folks that are like, “Hey, maybe I have a CPN. I’m paying them $1,000 a year. If I can get a total wealth management for $3,000 or $4,000 bucks or $5,000, is that worth?” It depends on how much money you have, but I mean, it does feel like though it’s going to change pretty significantly. One interesting data point we have is McKinsey says there’s roughly $66 billion in annual fees across 42 million households that are good candidates for some virtual financial advisor in the future, some AI-powered advisor.
That’s the thing we’re working on in our platform today. Advice can help lots of people. It just needs to get in the hand… It needs to be democratized.
Eric: I agree. Also, the hourly model makes a lot of sense to me, but this is going to be potentially harder to disrupt, but I don’t know, because you don’t write a check with a percent fee, so you don’t feel it. But I think if people wrote a check instead of the percent, I think that would expedite this, but it’s probably going to take a long time. The advisor, unlike a mutual fund, has an actual relationship with the person. That’s a big advantage. There’s a couple things that I think will prolong this, and the advisor, by the way, I find…
I wrote this article talking about how there’s this weird thing going on, where you know how advisors drove the move to passive. Once an advisor went from getting a commission from the mutual fund to getting a percent of the client’s assets, they immediately went to low cost stuff, because now it’s coming out of their pocket. So, that really… The percent of advisors that are fiduciary fee only is completely correlated to the move to passive. A lot of them are bogleheads, and they went into this business because they like to have good outcomes from the client.
But what’s interesting is as they really whittle down the fees and the revenue of the asset managers, those guys are going to start launching advice business. So, they’re both going to do both, and it’s going to… It’s almost like there’s three people, but two chairs. It’s going to create some kind of a consolidation if you have both companies doing both things. Some of advisors launch their own ETFs now, and so I think you’re going to find a lot of… What’s the word I’m looking for? A lot of consolidation, a lot of people hustling their way to create value in different ways. Again, I wrote about this in the book called the Bogle Effect, because if you think about it, Bogle, in my opinion, unleashed all this.
He created something that for advisors, they had to leave the system to go use. So, I think he actually sparked and fanned the flames of the RIA movement. These brokers were like, “I cannot put my clients in these crap funds just because they get a kickback.” There’s this better way now, and it would nod at their consciousness, and they left, because you couldn’t use Vanguard at these brokerages. So, a lot of them had to leave the whole system. That’s how Ballsy Bogle was. He basically set up something that had no distribution fees in the ’70s when everybody was paid that way. He basically said, “You have to come to me if you want this.”
That’s why it took Vanguard so long to take off, but I do think he had a role to play in forcing that RIA movement.
Steve: It’s interesting. It’s interesting how eventually the right idea will win, but it can take a long time. You hear stories about these proprietary funds that get created inside these warehouses, and it’s like, “Well, hey, you’re invested, but now if you want to leave, it’s going to create this giant tax obligation that we didn’t tell you about.” So, you’re almost forced to stay. You hear stories about that.
Eric: Well, by the way, I would love to get your take on this. Our team talks about this. Right now, well, say there’s about, I don’t know, 11, 12 trillion in active mutual funds. How much of that money do you think would leave if it could or is trapped there because of tax threats?
Steve: I mean, it can be… I’m sure it’s material. I have a friend of mine. He owns a ton of Apple. I feel like he’s like, “Okay, good. I’m rich.” He’s owned it for a long time, but he is like, “I can’t…” He has to be really careful about how he sells it, and what he is going to do with it and everything else, because there’s so much equity trapped inside that thing. So, actually when I was talking with Professor Malkiel yesterday, he was telling the story about… He had wrote this book 50 years ago, A Random Walk Down Wall Street, where he looks at all the data, and he is like, “Hey, it looks like if you just buy… You’d be better off buying an index of all the funds, of all the stocks versus buying individual stocks.”
When he came out into the industry, and Smith Barney, everyone was trading individual stocks. They were getting promoted, and they would come up and then come right back down, so these didn’t exist. Then he’s like, “Well, Jack Bogle came up with the idea of let’s do this.” He was sharing the story about how they tried to go public, and they’re like, “We want to raise $250 million.” Let me know if I have the numbers wrong, but he’s like, “We want to raise $250 million.” Then the underwriters were like, “Actually, we can only get half of that.”
Then they kept on cutting it back, and they ultimately did the first index fund, and it raised $11 million or something like that to get started.
Eric: That’s exactly right. All that’s exactly right. I love business stories where you put… It’s hanging on by a fingernail, and you realize it could go the other way. It’s good because those stories can give you faith to just keep walking when it’s dark out. I think this is one of those exact stories. This is why I give him… I refer to Bogle as a bit of a punk in the book, because I think not paying brokers at that time was just really, really… It was such a brave move because, again… At the time, the index fund was charging 40, 50 basis points. It wasn’t 10 yet.
But anyway, I think he did have the Wellington funds to give him some subsidy for that bravery, but still, it was way ahead of its time. The index… Honestly, nothing really took off for Vanguard for quite a while. The first 80 months of the firm’s inception, there were outflows from the Wellington Fund, so they had nothing going on. There’s times where I was studying his life, and I was like, “I probably would’ve…” He had small… He had kids. He had kids our age that the kid the same age our kids are if they weren’t like 40, or they were in their teens.
So, it’s a lot of responsibility. So, I’m like… I could see just leaving all that, and getting a nice cush job, vice president somewhere, and just live my little life and not worry about it, but this guy was just a fighter on a mission different person.
Steve: No, it’s interesting. It was when you were up at the conference, and hearing some of the stories about the decisions he made, and just the way he was as a person. One of the big things that I appreciate about him was that he mutualized the company, and basically gave up probably, I mean, definitely a huge amount of personal wealth that he could have created, and maybe it wouldn’t have gotten created if he didn’t mutualize, because mutualization was part of aligning himself with the investors, and driving to lower fees and the whole thing. But any other stories that jump out from you since you spent a lot of time interviewing him, and that go to his character?
Eric: I mean, just talk about the mutual for a minute. A mutually-owned company, part of the reason I wrote the book is that nobody’s copied that since. Vanguard is the biggest mutual, Vanguard has 27% of all U.S. fund assets. That’s double any other company in history. Fidelity had the last high water mark at 14%, and nobody’s copied this firm structure. I was like, “That’s crazy. It just deserves study.” I think that’s part of what makes Bogle so unique. I think those early days when he had that structure, essentially, what you give up… He had money. Let’s just say he wasn’t in the woods eating bugs.
But when you do a mutual structure, you still get paid. You get a nice salary, but you give up this jackpot, this Jeff Bezos level rich, because the owners are now the shareholders. You could never be the owner, and you could never be a billionaire. So, you give that up, but you make a nice salary. It’s just very unusual for someone to go to Wall Street who would do that. It’s against the type of people who go to Wall Street. They want money. They’re driven by money. Bogle, I think, was almost miscast, and so one of the stories I go over in the book was that the whole reason he ended up in this industry was because for his senior thesis, he didn’t know what to write about.
He found a magazine, a Fortune magazine, lying around in the library at Princeton, and in there was an article on mutual funds, and he was like, “Oh, this sounds interesting.” It was basically the… That industry was just beginning, and he wrote about that. That got the job Wellington, and then in this industry. But as I said in the presentation, the cover of Time at the same time was Conrad Hilton. You could think, “Well, maybe he just picks up a magazine that is Time, and now he’s in the hotel business.” I don’t think this is the classic Wall Street kind of guy.
I think there is something about him psychologically also that would allow him to do this. I have a chapter in the book called Explaining Bogle, because I try to go into the 10 things that went into this person, both genetic and environmental, that would create somebody who would do this, because it doesn’t… It’s like an anomaly in physics. It doesn’t make sense to give up all those personal gains. That is why I wanted to write the book. Again, it was studying something very unusual that you never see, but I did find in the book that Bogle loved adulation. So, I think the St. Jack stuff, it really fit the hole he was trying to fill inside.
We all have holes inside of us, right? He was trying to… He wanted to be liked and appreciated. Rich was… He just was immune to money in that way. So, I think that’s part of the psychological makeup that made it possible, but there was also a variety of other things, I think, that went into it, but that is, again, part of the unique story of him is that mutual ownership structure. It’s really the essential thing. But even though nobody’s copied it, everybody has to copy it now. BlackRock, Fidelity, they all have to have five basis point index funds and ETFs. They have to.
They probably don’t want to. Maybe some do, but so you see why it’s called the effect, because it’s not just Vanguard. What he forced on everybody else is astonishing. He changed the whole industry. Almost all the money now goes to the things that he basically invented, and forced other people to follow. So, even though nobody’s copied that structure, they’re largely governed by it.
Steve: I think it would be interesting to write a book about, and it could be in the finance industry, or about why people get into these businesses, where they came from. When I was talking with Burton Malkiel, he is like, “Hey, I grew up poor in Roxbury, in a tenement house, basically. I had no money. I was good at… I was fascinated by stocks, and I was good at math. I went to Harvard, got an MBA, and then went to the army briefly, and then took basically a job on Wall Street, because I want to get rich.” He works on Wall Street, and then he is like… But at the same time, he is thinking, and he is like, “But this is a lot of… There’s a lot of noise here, and a lot of hot air. Really, there’s some bad stuff happening here, and it’s taking regular people’s money.”
Then he completely shifts gears and devotes his life to exposing the inefficiencies in the space versus… I’m sure he could have stayed and printing money the whole way along, but he tries to do his stuff. Then he hooks up with Jack Bogle. It’s just interesting how probably… There’s probably a cast of characters that are for various reasons got together, put their heads together, and said, “Let’s do the right thing here.” Then it’s taken them 50 years for it to emerge that this is the right path. It’s backed with data, and now, everyone’s on board with it.
Eric: No, they ended up being right, and I get it. I think how people get into industries is very interesting to me. It’s important if you’re doing a character study, you need to find that out. So, Bogle’s wasn’t exact… It wasn’t like he was six years old, and said, “I’m going to start a mutually-owned company.” A lot of this was circumstantial, and there was three points in his career where it was like a one in 1,000 thing that happened, that if it didn’t happen, you probably don’t have Vanguard. So, there was some luck involved, but I think the really great people take luck and opportunity, and really capitalize on it.
But it’s funny when you keep… You mentioned Malkiel. I have just a little story about Bogle that just tells you how hardcore he was. If you Google Princeton common ownership, Malkiel, Bogle, these guys all met, I want to say, five months before Bogle passed away. They’re all 89. They get this group together, because there’s this worry about common ownership. It was a paper out of Chicago, and the media covered it a little bit. Index funds are going to ruin capitalism because of common ownership. We know it’s funk, but Bogle, he’s 89, and Malkiel’s 87 or something. They meet in Princeton. They taped this session.
It’s got Gus Sauter who used to run Vanguard, Cliff Asness from AQR, Andrew Lo of MIT. I think I’m missing a couple of people, but there was 10 of them around this taped conference room at Princeton. They’re just debating this issue for, I want to say, two and a half hours. Watch the whole thing online. I’m like, “Man, that’s a whole nother level of dedication to this cause,” because at that age, you could totally be like, “I’m done,” or you could have been done 10 years ago. I don’t know. I thought… I also think being a little pissed off and passionate about something is part of the key to longevity. I think you need something to get your juices flowing, get that blood pumping. I think for Bogle and Malkiel, this is one of those things.
Steve: That was one of the things that was a shock to me. When I saw him at the conference, he was on video, but I was like, “Wow, this guy’s sharp as a tack.” He’s got to be approaching 90, and he’s still full of energy ,and everything’s there. I totally agree with you. I think for people that if they’re really good at things, they would do it even if you didn’t pay them. They’d be like, “I don’t really…” They’re not really there for the money. Money’s good, and people wants to be recognized. It is other things. It’s like they believe in the cause, or they want to be celebrated, the ego and all that stuff. It would be interesting to analyze folks and understand what drives them.
Eric: I also think that Bogle was necessary for this industry. It was getting… It’s not appropriate for a fund that has $100 billion to charge 1%. That’s a billion dollars a year. That is so much money for that job to society. That’s why when Vanguard came out, and lowered fees as they got bigger, which is called passing on economies of scale, it was arguably just the right thing to do. Whereas some of these funds kept the 1% as they went from 1 billion to 10 billion to 20 billion to 30 billion, the dollar fees are going up and up to astronomical levels. They missed an opportunity. A lot of the industry, I think, should have passed on some of that.
They would’ve been less disrupted as they are today, but I think in this industry, it’s different than other industries, and that you could be not that great at your job, and you can just be lazy too. You’re going to make more money, because as long as the stock market keeps going up, which it does, your 1% will grow even if you get no new customers. So, I do think this is a industry that probably needs people like that, because it’s so easy to make way too much money for what you do. It’s great. People need to make money. It’s important, but there’s some tasks in this industry that it’s unbelievable the amount of money for that contribution to society.
I mean, it’s all legal, but it’s something that you need these freedom fighter guys and gals to be out there doing this. That’s one thing I really give credit for Bogle. He did it using capitalism. I would say Bogle did more to reform Wall Street than Bernie Sanders can ever dream of. Bernie’s all talk. Even if Bernie got a bill passed that was a way to regulate Wall Street from these exorbitant dollar fees, it’s possible that the other party would get over and undo the rule. What Bogle did was he changed it from inside using capitalism, and now it’s pretty permanent.
It’s just not going to change, and that is an awesome feat. But again, it took him 40 years to do it. It was not overnight.
Steve: I know. You can make a fortune in financial services, but it does feel like it’s a 10, 20-year effort. Totally. I mean, you have to use the market. I’m a capitalist, but I’m also Silicon Valley. You have to believe in innovation and hard work, and then that is what leads to change. No, I mean, look, in our business, our paying customers manage $15 billion of their own money. If we were charging them 1%, we’d make 150 million a year. I mean, I’m looking at these numbers, because I’m in the space. We would be a massive, fast-growing RIA, but instead, we make…
It’s such a small fraction of that, because we charge software fees, but I think it’s worth something like us and flat fees. It’s more where the world’s going to be, because there’s so much money at stake in innovation. Also, I think people will look at this. For me the other day, I was looking at my Wells account, and I was like, “What are these fees?” It’s like, “They’re charging me these fees that seem stupid.” It’s like, “There’s freaking 50, 60 bucks a month in fees here across these dumb accounts that are just not necessarily all need to be there.”
But I’m like, when people start looking at this stuff, they really have to feel like there’s value. Otherwise, they’re going to throw up, and then these customers are going to walk. I think you have to be careful about… Make sure you’re delivering enough value. Don’t piss your customers off, and just build for the future, not for the past.
Eric: Absolutely. You get it. I describe Vanguard this way in the book Psychic Income. You have to enjoy that. If you don’t, you probably wouldn’t work at Vanguard, or do what you do. Psychic Income, I think, is with some people in the government. Malkiel probably would say that, because he could probably make more money at a hedge fund, but Psychic Income is great. It gives you that feeling of purpose, and that’s, I don’t know, hard to put a price tag on that. But again, this is a luxury to talk about it given you do have your baseline expenses covered.
If somebody doesn’t have any money, you got to hustle, and make as much money, but there is a nice… There’s income that isn’t seen, I think, that that is there for people who are going and doing these more low-cost ventures, but it’s not easy. Like I said, you could easily imagine what if. What can I buy with all the money? The revenue would be so great. I get it. It’s tempting.
Steve: 100%. Before we move off the book, and move to the close here, any last things you want to call out that big insights you had from writing your book, or things that you think tip the average retail investor should pay attention to?
Eric: I mean, I think one of the interesting takeaways from my book is, of course, Bogle had an impact on the funds business. He had an impact on the passive and the advisory business, and he had impact on behavior. I think index funds make it much easier to behave well during drawdowns. One of the things that I wrote about that I think is underappreciated, but something that’s happening right now is the more passive takes up the core of a portfolio, the crazier active and ETF launches are going to get. There’s this weird barbell happening now, where if you have Vanguard 500 or the total market as your core, you have all the serious stocks covered.
You have Apple and Microsoft, and even the energy companies and the value stock. It’s all there. What people are doing is they’ve got 85% in this cheap beta 60-40, but then they want to go wild with 10%, 15%. I call that hot sauce, and because the cheap beta is very effective, especially the compounds, but let’s be honest, it’s a little boring. So, people now are looking for things to decorate, and so part of the Bogle effect ironically is making more active. Kathy Wood, she only holds 25 stocks. More ETFs are launching with less and less number of stocks, so they increase the volatility or the hot sauce kick.
Thematic ETFs are part of this. Crypto’s part of this, and so that hot sauce lane is going to be where you’re going to see so much stuff thrown at the wall. It would be the opposite of… Bogle would find it all detestable, but in a weird way, he’s responsible for it. Believe it or not, some of that stuff’s going to have a long shelf life, because if you have… Ark is a great example. People may hang with Ark more than people think simply because she’s not the college education fund. She’s not your retirement fund. She is curing your FOMO. Just in case this lady’s right, and we’re going to have taxis and robots flying all over, I want to participate.
I don’t want to have FOMO that I missed out on this crazy future, or crypto. Same way. I don’t get it, but I don’t want to be like 30 years from now, “Damn, I should have bought a coin” There’s this lane right there that I think is going to be really interesting to watch, and it is totally a byproduct of the Bogle effect, although one he would not have liked.
Steve: But probably the most efficient way would be to basically index those things, and just spread your bets on the craziness instead of like…
Eric: That’s why we sometimes advise… We write to terminal clients, and we’re like, “You have to go where the index isn’t, because if you can be indexed, you’ll be commoditized.” So, Kathy Wood, love her or hate her, she’s unindexable to a degree. I mean, there is some correlation with Goldman Sachs non-profitable tech basket, but by and large, she has 98% active share to the S&P, so it’s like… She’s very different. So, I think over time, that lane will… You’ll see some of the legacy active managers who do closet indexing active reinvent themselves with their best idea funds, because people think these…
People don’t think these mutual fund companies are dumb or not smart. They’re bright people. The problem is they’re too close to the index, and minus fees, they usually lose to it. So, why not just buy the index? That middle, high-cost closet indexing, I think that’s going to go away. I think they’ll reinvent themselves as, “Look, you know I’m smart. Here’s my 30 best stocks. These are stocks I really like.” That, you can put on top of the Vanguard core as a compliment, and I think that’s where we’re going to see active go. I don’t know if that’s… That’s one of the more non-obvious parts of my book, I think.
Steve: That’s interesting. That’s an interesting insight. I mean, we’re definitely seeing it out there. People are definitely… They’re into these much riskier things right now, and some of them in with way too much concentration but…
Eric: I will say if Ark took in Vanguard money, and Vanguard took in Ark money, I’d be worried, but Ark is… Vanguard… Ark has 16 billion, right? Vanguard takes that in in three weeks, so the cheap beta is so much bigger at taking in flows. It just doesn’t get much press, because it’s boring as hell. So, proportionally speaking, that hot sauce lane is small. I’m just saying 15% of all the flows in America is pretty good. I mean, you could live on that, but 85% is still going to this very cheap beta. I would maybe throw in cheap smart beta in there, but that stuff’s all been commoditized, and that takes in the big boy money.
Steve: What does Vanguard have in total AOM right now?
Eric: I want to say it’s about 7.5 trillion. It was 8.3, but the market obviously brought it down this year. BlackRock has about a trillion more, but we’ve done the study. BlackRock, a lot of their money comes from global and institutions. But in the U.S. fund business, Vanguard crushes everybody, but Vanguard’s actually going to pass BlackRock, we think, because each year, they nibble away at the difference. So, the percent gap between BlackRock and Vanguard is now 16%. BlackRock has 16% more total assets, but that number was 50% seven, eight years ago.
So at this trajectory, Vanguard probably will be the biggest asset manager globally as well as the funds, which they already are. One quick point on this, which is a good note to end on, and you saw this in my presentation, Bogle’s known for these quotes like, “Don’t search for nail in the haystack. Just buy the haystack,” and other, “Don’t just do something. Sit there.” He has 10 of these Ben Franklin quotes that people use. I read a quote in one of his books doing research that I did not know, and I was blown away by this. He said in his book, Character Counts, he said he told the crew one day, that’s the employees, that I will know that Vanguard’s mission is beginning to be complete when our market share begins to erode.
You said this in 1991 before they were that big, but that is quite a vision, because, a, that means that he will have forced everyone else to get so good at being low cost and stewards that finally, the people would start using them too. The idea of that is still not happening. So, we have this theme with Bogle’s dream is not yet fulfilled. Their market share keeps going up and up and up, but at some point, it will plateau, but that is… I’ve asked… I’ve done this presentation for this book in front of, I don’t know, maybe 20 crowds.
I’ve asked everyone, “Do you have any examples of a CEO rooting for their market share to erode?” I’m yet to have anybody who’s has a precedent for that. I think that had just really epitomizes why this is a weird unusual person.
Steve: Well, it’s interesting. I think visionary people do. I mean, I will say Elon Musk, who he’s going through his own crazy period right now, but he did say he had a vision where, “Look, we’re going to build electric cars, because that’s going to be the way to change the world, and get other car manufacturers to follow suit.” I think if you want to make real change, you have to do that. You can’t do better, faster, cheaper, which is one way to build companies. You have to do brave new world. I’m just going to come out and show you this new way to do things.
Then he also built the whole manufacturing stack, the whole charging stack and everything else, and he’s forced the rest of the industry to move along and come along. I think he did say something like, “Eventually, they’re going to copy us, and our margins low road, and we’re going to suffer. But it can take decades.”
Eric: That’s a fair example. Also, Steve Jobs famously said, “If you don’t cannibalize yourself, somebody else will.” He kept lowering the price on the iPod. I think you’re right, and I think Bogle… In the beginning of the book, I say that he was a combination of Steve Jobs and Martin Luther, the Protestant reformation guy, because he created a religion in a way with Bogleheads and all that, but the one difference between those two guys at is that mutual structure. They’re both… At one point, Elon was the richest man on earth.
Now, maybe he doesn’t care, but that idea of sharing all the profits with the customers, I think that could be really interesting to apply to the space, like the electric vehicles. I think that would’ve really created something even more powerful than he had. But to your point, a innovator comes along. He’s going to force the rest of the industry, or she, to comply if they have that big of a vision. I think those guys come along once a decade. It’s that mutually-owned thing that makes the Bogle story just gives it that extra uniqueness in my opinion. Because like I said, he’ll never ever make that Forbes list.
Steve: Right. It’s tough. You do have to have… I like capitalism for… I mean, part of capitalism is people can get rich, and get obscenely rich. For a lot of people, they find that highly motivating, and they’re going to go for it, and you need that. You need people going out there and taking risks, because they’re betting at all. When people start companies, it’s usually not people that have tons of money. It’s people that like Bogle. They have kids, and they could lose it all. There’s bad things that… There’s bad downsides, and most companies fail, and it’s not great.
You only hear about the ones that survivors buy. We only hear about the winners, right? They’re like, “Hey, I killed it. I made a billion dollars.” about the 10,000 other people that are like, “I ruined myself, and burned every last penny I had,” and even worse.
Eric: I mean, you bring up a good point. I was in Australia, and I made the same point. There are certain people who do want the money. They want the power. They want to have the money just to give it away. You’re right. You need that pot of gold there to motivate, and I love that. I love capitalism. But again, the Bogle story is so interesting because he had the motivation without the pot. He already forego the pot, and he was just as motivated. That’s a weird combo. But like I said, I think I would definitely put him in with other innovators from those businesses that you mentioned.
Steve: 100%. He’s had a massive impact. All right, well, look, Eric, this was great. I’m just going to close this out. So, thanks, Eric, for being on our show. To our audience, thanks for your time. Definitely check out Eric’s book, the Bogle Effect. We will post the link on the show notes for this. If you need help with financial planning, check out newretirement.com or our community, and any feedback via reviews is totally welcome. Appreciate your time, so thank you.
Eric: Thank you very much.
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