22
THE MAJESTY OF SIMPLICITY
On Receiving
The Honorary Degree as Doctor of Laws
from the University of Delaware
Newark, Delaware
October 22, 1999
LET ME FIRST express my sincere thanks for the signal honor you have just bestowed on me. I accept it with great pride, enthusiastic delight, and considerable humility. Earlier in my life, there was a point at which I actually considered becoming an attorney, and, with luck, perhaps ultimately even a respected jurist. While that dream has long since vanished, my designation by your Trustees as Doctor of Laws through the award of this Honorary LL.D. degree will be a wonderful reminder of a legal career that might have been.
Your award, interestingly enough, comes at a major milestone in Vanguard's history. Only a few weeks ago, we quietly celebrated the 25th anniversary of our founding: September 24, 1974. Since we began, our industry—driven by the great bull market in stocks and the ever-growing acceptance of the mutual fund concept—has burgeoned 150-fold in assets, from $40 billion to $6 trillion. But Vanguard's 500-fold growth in this period—from $1 billion to $500 billion—has marked us as the fastest growing firm in the entire industry.
The explanation for that success—although, to be clear, I equate neither giant size nor rapid growth with success—is not very complicated. Our defining quality, I think, is our recognition, a quarter century ago, of the majesty of simplicity. If Vanguard has dared to strive for greatness, it is because we have tried to live by Tolstoy's standard:
“There is no greatness where there is not simplicity, goodness, and truth.”
Common sense investing is grounded in simplicity, but it requires faith. In the very first paragraph of the very first chapter of Common Sense on Mutual Funds, I write: “Investing is an act of faith. We trust our capital to corporate stewards with the faith that their efforts will generate high rates of return on our investments … and the faith that the long-term success of our nation's economy and financial markets alike will continue in the future.”
The problem with investing, as it turns out, is not faith in our financial markets, for they have provided us with bounteous returns. Rather it is faith in our financial institutions, for the stewards of our assets have failed to capture for investors a fair share of those returns. Because of the excessive costs of participating in the markets, the principal challenge you face as an investor is to at once realize the highest proportion of the market return earned in each asset class in which you invest—stocks, bonds, cash reserves—and at the same time to recognize, and to accept, that your portion will be less than 100%.
Few institutions—and certainly precious few mutual funds—have offered their services at costs that are sufficiently low to enable their investors even to approach the 100% desideratum. Indeed, over the past quarter-century, fund management and marketing costs have confiscated some 40% of the stock market's cumulative profits, leaving but 60% for the human beings who, after all, put up 100% of the initial capital and took 100% of the market's risks. Such an outcome simply doesn't comport with my notion of fairness.
Since our inception, Vanguard's stock in trade has been the notion that in minimal operating costs lay the key to approaching 100% of the market's return. The unifying theme in everything we do is rock-bottom expenses. It begins with our mutual mutual fund structure. At the outset, we broke new ground by having the mutual fund shareholders own the funds' management company, which in turn operates on an “at-cost” basis. Just a few months later, we broke new ground again, bringing the idea of low-cost investing into crystal-clear focus by forming the first index mutual fund. In its ideal form, the index fund owns a pro-rata share of every security in a given market and virtually guarantees almost—but not quite—100% of the market return. As a result, it provides its participants with certainty that their returns will outpace the returns of all other investors as a group.
To explain why that proposition must be so, the analogy of the casino proves to be apt. Gamblers in the real casino play a zero-sum game until the croupier's rake descends and takes its share. It then becomes a loser's game. Investors in the stock market casino, too, play a zero-sum game in terms of beating the market, but, again, only until the croupiers' rakes descend. Then, it too becomes a loser's game. With so many croupiers raking off their shares—fund managers and marketers, investment bankers and brokers, even the Federal and state governments—investors who bet on every stock in the market, exit the casino, hold their stocks forever, and never again darken its doors, earn long-term returns that put those of the active participants in the financial markets—those who remain in the casino—as a group to shame. Yes, there are going to be some long-term winners, but they will be few, and virtually impossible to identify in advance.
In essence, investing in highly diversified portfolios focused on high-quality stocks and bonds, holding trading to a minimum, and operating at bare-bones cost proves to be the key to investment success. Today, that perspective may seem obvious. Perhaps it always was. One writer, determined to explain the many simple innovations we have brought to the world of investing in stocks and bonds alike, laid it to what he called my “uncanny ability to recognize the obvious”—a wonderful paradox, since the obvious ought to be something anyone can recognize. But however obvious, the notion that there is inevitably a gap between the returns the markets provide and the returns investors receive is gradually reshaping the way Americans invest.
Why did it take so long for the greatness of simplicity in investing to emerge? Remember what Tolstoy said: Greatness also requires “goodness and truth.” While many financial firms may well have recognized just as easily as I did the mathematics of the marketplace that defines investment success by the apportionment of returns between the investors and the managers—even as between gamblers and croupiers—external fund managers had a powerful vested interest in maintaining their own extraordinarily high profitability. We alone had an internally managed structure, a structure that would provide a measurable goodness, if you will, to investors. It is putting the investor first that has given us the highest motivation, reinforced by our will and our determination, to act on such an obvious proposition and drive it to its full fruition. “The greatest good for the greatest number.” Jeremy Bentham would have loved it.
Tolstoy's third element of the search for greatness—truth—also played a vital role. Our simple investment philosophy speaks for itself. In a business where marketing has become the highest priority and hyperbole the order of the day, our investment strategies are clear and uncluttered. We can not only honestly report what our past returns were; we can explain why and how they happened. The superiority of the index approach has been endlessly tested in academia and has not been found wanting. Indeed it is a rare MBA student today who has not been schooled in the very theory that we have made work in practice. All we had to do was keep driving the message home. At the outset, of course, it seemed counterintuitive, even ridiculous. But with the truth in our arsenal, we enthusiastically became the apostles of indexing and index-like strategies, the disciples of low cost. It's been wonderful not only to witness the investment world change, but to help it along the way. And it is the investors of America who are the winners.
Our simple investment philosophy has been a condition necessary to our success, but I think not a condition sufficient. For that condition, I turn briefly to the other main element of Vanguard's focus on service to human beings as the core of our business philosophy—“honest-to-God, down-to-earth human beings, with their own hopes, fears, and objectives.” I've said it 1,000 times over. Even with 12 million shareholders, we strive to treat each one as an individual. We do the same with our burgeoning group of Vanguard crew members, now 10,000 strong, who have coped so beautifully with our astonishing growth and contributed so much to our success.
Our Award for Excellence is embossed with a phrase I've used ever since we began 25 years ago: “Even one person can make a difference.” Only as the idea of treating human beings with respect, fairness, and compassion permeates our enterprise can we truly emerge as the honest stewards of our investors' assets, hard-earned and vital to their future security. Living this philosophy with those with whom we serve at Vanguard, and with those whom Vanguard serves, may sound like the Golden Rule. So be it. Such stewardship is just one more piece of evidence of the Thoreau-like simplicity that permeates our mission. “Our life is frittered away by detail. Simplify, Simplify.”
As I move into the late stages of my long near-half-century career in this industry, I must admit that I don't spend a lot of time basking in the success of the investment strategies we've provided to investors, nor in the success of our enterprise, nor in dwelling on either the many challenges or the few disappointments I've encountered along the way. I look to America's future with the same idealism and hope that I've always had, and to Vanguard's future with confidence that our great warship will stay its appointed course long after I'm gone. For I believe the investment ideas and human values with which I've endowed the firm that I founded 25 years ago, those that I've sketched out today, are not only enduring, but eternal.