John Bogle is the Founder of The Vanguard Group, Inc. He created Vanguard in 1974 and served as Chairman and Chief Executive Officer until 1996 and Senior Chairman until 2000. The Vanguard Group is one of the two largest mutual fund organizations in the world. If anyone can speak honestly about the effect of fees, both disclosed and hidden, that mutual funds have on the growth of mutual fund account values, it is John Bogle. 401k plans offerings are nearly entirely composed of mutual funds.
PBS: So what do you say to the great mass of people who feel terrific about putting away 6 percent a year, with a 3 percent employer match -- that is, 9 percent a year combined starting at around age 35? What do you say to them?
Bogle: You'd better step it up if you're putting 9 percent in at age 35, and you'd better also do some other very significant things. One, you'd better keep [the investment] costs down so you aren't overwhelmed by the tyranny of compounding costs, whatever market return you might get.
... Investors should realize [they] don't get the market return. In a 9 percent market, we all share 9 percent before we pay the cost of financial intermediation, and after we pay those costs, which are about 2.5 percent a year, we get 6.5 percent on a 9 percent market.
PBS: So if I do your average, what percentage of my net growth is going to fees in a 401(k) plan?
Bogle: Well, it's awesome. Let me give you a little longer-term example. The example I use in my book is an individual who is 20 years old today starting to accumulate for retirement. That person has about 45 years to go before retirement -- 20 to 65 -- and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. So that's 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow in that 65-year period to around $140,000.
Now, the financial system -- the mutual fund system in this case -- will take about two and a half percentage points out of that return, so you will have a gross return of 8 percent, a net return of 5.5 percent, and your $1,000 will grow to approximately $30,000. One hundred ten thousand dollars goes to the financial system and $30,000 to you, the investor. Think about that. That means the financial system put up zero percent of the capital and took zero percent of the risk and got almost 80 percent of the return, and you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return. That is a financial system that is failing investors because of those costs of financial advice and brokerage, some hidden, some out in plain sight, that investors face today. So the system has to be fixed.
PBS: I've got to unscramble what you just said. You said that in the case of the $1,000 invested for 65 years, the financial system is taking 80 percent of the money. But most of us aren't doing that. In the first place, at 20 we're out spending it; we're not putting it away. But set that aside. We're really talking about people who are probably saving from 35 or 40 or 45 at best for retirement at 55, 60 or 65. and they are plunking the money away into 401(k)s. I'm just asking you, in that system, roughly what chunk of it are people getting back themselves out of their gains, and what chunk of that is going to go to the financial system for managing their money?
Bogle: Well, in the long run, it's 80 percent to the financial system, 20 percent to you. In a given year, it's about 80 percent to you and 20 percent to the financial system, so if you look at 10 years or 15 years, you're probably talking about 60 percent to you and 40 percent to the financial system maybe over 20 years, something like that. But the longer the period, the greater the impact of that tyranny of compounding costs is.
Full Interview can be found here: http://www.pbs.org/wgbh/pages/frontline/retirement/interviews/bogle.html
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