Curious Capitalist

Mutual Fund Pioneer Jack Bogle: How to Fix Wall Street

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John C. "Jack" Bogle, founder of the mutual fund company Vanguard Group Inc., speaks during a panel discussion at the John C. Bogle Legacy Forum, named in his honor, in New York, U.S., on Tuesday, Jan. 31.

Jack Bogle, the founder of mutual fund giant Vanguard, and the man who popularized index funds, is part of an older generation of financiers, including people like Warren Buffett, who believe in long-term, low-cost investing, paying their taxes, and giving away most of their money. And like many of that generation, he’s worried about how short-term thinking has corrupted the markets and endangering our economic future. His 11th book, “The Clash of Cultures: Investment vs. Speculation,” is a highly critical, numbers-driven look at how Wall Street went wrong, how it’s screwing up both the economy and our retirement prospects, and what we can do to fix things. He spoke with TIME’s Rana Foroohar about the book, and what’s rotten in the markets today.

Q: There’s so much more turnover in the markets now – exponentially more – than there was in the early 1980s. What changed? How did investing become so speculative?

Bogle: There was a big acceleration around 1980, when companies began using stock options to fund corporate compensation. We moved to a system of compensation that was based on stock prices rather than on intrinsic values. Suddenly, you are paying executives [not to run a company well but] to raise the price of their stock – and that’s a bad innovation. The bull market of the 1980s didn’t help things, because it made it all seem so easy, and you had a lot of new mutual funds taking higher fees. If you have a 17% return, who cares if you are paying 2% fees? People just didn’t worry about costs, which is a bad thing.

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Q: Bill Gross, the head of PIMCO, says we’ll never see those kinds of double-digit returns again; in fact, he’s not sure we’ll even see high single digits. Do you agree?

Bogle: Well, I don’t think his view is bearish; I think it’s accurate. [In a balanced portfolio of stocks and bonds] you might get a 7% return. And that’s assuming 2.5% inflation, which could be much higher over the longer term. The bottom line is that we won’t see the kinds of returns we saw in the past and we have to revise our savings plans for the future. People have to save more, and compromise on their quality of living in retirement. Or, they have to earn a higher return. And I think that given higher volatility in the markets, going into higher yielding bonds or stocks, the risker ones, is unadvisable.

Q: Are markets inherently more volatile than they’ve been in the last several decades?

Bogle: They are, although a bit less so this year. Volatility will be higher than in the past, but it always reverts to the mean. Of course, it would help if we could get some of the high-frequency trading out of the markets.

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Q: What’s the best way to deal with speculation, from a policy standpoint?

Bogle: I think you can do a lot with tax policy. Income earned by the sweat of your brow should be taxed at the lowest rates, not the highest. Capital gains should be taxed at a higher rate. You could have a transfer tax on stocks to slow down trading. About 60% of all US stock market investment isn’t even taxed at all, because it comes from pension funds, or endowment funds, or mutual funds, which are either tax exempt or passing on taxes to customers after taking their profits. I think we should also do away with carried interest exemptions for hedge fund managers. They pay the capital gains rate [for their work], not the income tax rate. So, you’ve got a system in which the richest capitalists are paying the lowest tax rates. That’s just wrong. It should be changed.

Q: What would you say to people who claim that higher taxes on capital gains would penalize job creators?

Bogle: That’s absolutely not the case. On page 5 of my book, you can see some numbers showing how only about 1% of money in the market is going to new companies via IPOs and other issuances. 99.2% of it is going to traders.

Q: And what would you say to those who worry that higher taxes on those capitalists, as well as on financial institutions, would make our markets less liquid, and thus less safe and efficient?

Bogle: I’ll tweak a Samuel Johnson quote, and say “Liquidity is the last refuge of the scoundrel.” The fact is that most people in the financial industry, on the left, right, and center, people from Lloyd Blankfein to Mary Shapiro, all say the same thing, which is that the majority of capital should go to business [not to traders].

(MORE: The S&P Soars, the Economy Snores)

Q: What could be done to ensure that it does, aside from tweaking tax policy?

Bogle: I think you could have a federal statute requiring investment advisors large and small, institutions and individuals in the profession, to observe a fiduciary duty around things like reasonable costs, good corporate governance, and conflicts of interest. I also think that there’s an individual solution, an “Adam Smith” type solution as I call it, in which investors could just start moving their money to places where they get more of a fair shake. And I think you can see that they’ve done that, to a certain extent, already — Vanguard now represents 40% of the entire cash flow of the mutual fund industry. I think high costs [eroding already lower returns] are as much of a risk for investors as the [economic situation] in Europe or China.

15 comments
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rpsmith121
rpsmith121

People should know that taxes on dividend income is taxed as ordinary income.  And this actually represents double taxation becuase dividends are paid after corporate taxes have been paid.  So, I'm in favor of raising taxes on capital gains but I believe the double taxation of equityt income dividends should be eliminated or at least diminshed to some degree.  Also, pension assets are taxed, just not until they are paid out to pension plan benficiaries.  Saying they are not taxed is inaccurate.  They are simply tax deferred investment vehicles to support retirees.

Jeanne Tucker
Jeanne Tucker

Unless you are the stock you own, then it isn't double taxation. Unless you want to be liable for all the losses as well as the profits. That is one of the dumbest ideas I've ever heard.  

rpsmith121
rpsmith121

Thanks for your point of view Jeanne.  I respectfully disagree.  If I own common stock, I own a proportion of the corporation and it's earnings.  As owner, I did pay tax on those earnings in the form of corporate income taxes.  Then the after tax dividend paid to me is taxed again as personal income.   Also, as an owner I am responsible for losses.  As losses are incurred, the value of my ownership (share price) declines and will be wiped out entirely should the corporation go bankrupt.   

davidrsmithdvm
davidrsmithdvm

I agree with Bogle and have been a casual follower for years to my regret.  If I had been more aggressive following his advice and could afford more investments I would be even better off than I am.  I think this speed or computer investing where you are in and out in minutes and 

hope some idiot is right behind you willing to pay a nickel more is wrong.  Only buy if you like the company and they pay dividends or you are going to hold for a time and see if they really do become more valuable like Microsoft did years ago or Apple lately.  Then in the end pay taxes unless you don't like highways, police protection, military, SS and all the other things a  tax (investment) gives  us.

AThoughtfulObserver
AThoughtfulObserver

The high frequency trading has got to go.  It creates a very un-level playing field.

akpat
akpat

This sums up what is wrong:

 Bogle: I think you can do a lot with tax policy. Income earned by the

sweat of your brow should be taxed at the lowest rates, not the highest.

Capital gains should be taxed at a higher rate. You could have a

transfer tax on stocks to slow down trading. About 60% of all US stock

market investment isn’t even taxed at all, because it comes from pension

funds, or endowment funds, or mutual funds, which are either tax exempt

or passing on taxes to customers after taking their profits. I think we

should also do away with carried interest exemptions for hedge fund

managers. They pay the capital gains rate [for their work], not the

income tax rate. So, you’ve got a system in which the richest

capitalists are paying the lowest tax rates. That’s just wrong. It

should be changed.

Darian L. Smith
Darian L. Smith

A steady and  stable growth is what most investors would like to see, rather than a wild gyration of extreme highs and lows.  Plowing some of the profits back to employees first would assure this. That might sound counterintuitive at first, but hear this out.  By  allowing businesses a tax credit for plowing up to 15-20% net profits back to employees first, it would stimulate a decentralized growth. More people would have more capital to buy more necessities.  This increased supply leads to an increase in demand.  Higher sales and productivity leads to more jobs.  This means lower investment gleanings in the short run, but a stable and steady built-in decentralized stimulus for the long run. Companies have less expansion capital, but they establish a solid market first, which is the definition of stability.  This is the missing link of supply-side economics, and the missing link of economic democracy.     See  www.profitsharinguprising.com  

scottindallas
scottindallas

 Higher top marginal income taxes do this on their own.   Higher capital gains rewards the holding of capital (through depreciation credits) rather than low cap gains which only encourage liquidation and speculation.

Nonaffiliated
Nonaffiliated

 So how do you differentiate profits sent "back to employees" from normal wages?  As an employer, I could reduce wages 20% and then give you 20% from "profit".  It wouldn't affect your take home any, but it would save me plenty on my taxes.

davidrsmithdvm
davidrsmithdvm

Year end bonus based on net income of profit after the employee has been payed all year.

Nonaffiliated
Nonaffiliated

So, employees at companies that lose money would get no bonuses.  I like it.  You make employee salary partially dependent upon overall corporate success!  That should stimulate some additional buy-in.   

TheGizmo51
TheGizmo51

It's not a fix for wall street but if stock and bond trades were taxed a lot of money could go towards reducing the debt.

Maria J. Stewart
Maria J. Stewart

More people would have more capital to buy more necessities.  This increased supply leads to an increase in demand.  Higher sales and productivity leads to more jobs. http://Zap21.com

AngelAlonso
AngelAlonso

Charlotte replied I'm blown away that any one can get paid $7567 in a few weeks on the network. did you look at this(Click on menu Home)