Eric Balchunas (03:42):

So you really just lower your volatility, it’s like betting on all the horses at the racetrack at once, and that way you can slowly benefit from what stock investing is all about, which is that people get up every day, they go to work and they create value at corporations, that value is transferred to them in the form of dividends and earnings growth. So what you’re trying to do is ride capitalism’s coattails, and that’s why stocks are such a great place to be. But diversification helps because it takes away the need to try to pick one. So if mutual funds came out to do that, some actively pick them for you but largely stay diverse, and then index funds came out after that, which is what Bogle really pioneered, which is let’s not try to fix stocks, we’ll just track the S&P 500, and that’s another version of diversification.

Eric Balchunas (04:23):

ETFs came along after that and said, “Hey, why don’t we do the same thing but we’ll let these things trade on the exchange like a stock.” So basically an ETF is simply a mutual fund that trades on an exchange, and it’s a big hit. Mutual funds you get in and out once a day, people just like the fact that you can fine sell an ETF anytime you want. ETFs are, I would say also a little more innovative and they serve a younger audience. I know this is the Millennial Podcast, if you looked at age group and percentage of portfolio and ETFs, it’s completely inversely correlated to age, the younger you are, the more likely it is that you have ETFs. So I would say mutual funds are sort of like the boomer type structure, ETFs are more for the younger crowd. And ultimately the younger crowd will grow up and they’ll… Who knows, maybe something will come in after that. But that’s sort of where we stand now, but an ETF isn’t that different than a mutual fund. It’s all about getting diversification, and then obviously there’s different ways and packages to do that.

Clay Finck (05:17):

Why do you think that the ETFs cater to the younger generations more to the older?

Eric Balchunas (05:23):

I think the ETFs fit into the digitization of things, they trade all day on the exchange, you can see the price. They also speak to younger people, a little more, the thematic investing, there’s not a lot of mutual funds doing that. Younger people launch ETFs, again, you go around and you look especially the smaller issuers. I mean, I’m probably older than most of them and I’m gen X, but there’s a lot of younger issuers and I think they also like the lower fees. I think millennials, I actually studied millennial portfolios one time and through the TD Ameritrade survey and I found that their portfolios really were futuristic. They had real cheap ETFs in the core, like Vanguard funds, and then they went hog wild on the outside. And that’s kind of what we’re seeing everybody do now and I think they like ETFs for the core.

Eric Balchunas (06:09):

So they can go on a platform like Robinhood or Schwab or TD Ameritrade, and they can have three or four ETFs basically for almost no fee that gets them like 70% of what they need. And then they can go crypto, or Cathie Wood or Ark, or themes. So when I wrote that five, six years ago, I’ve now really seen the flows do that, and so now our big theme is this idea of barbelling, where the money’s going to either dirt cheap or shiny objects. And that’s largely, I think in a weird way, pioneered by millennials who seem to have done that early on in their portfolios, at least according to TD Ameritrade surveys. It’s tough to get this data because it’s not like they don’t just share all millennials accounts online all the time. Sometimes there’s surveys or a company, a brokerage platform will show you, Schwab does some good ones.

Eric Balchunas (06:53):

So we’ve pieced all this together, we look at the flows and we feel like that’s what millennials like doing. And I think ETFs also, they have tickers that are three or four letters, they fit nicely altogether because a USB it fits into any computer anywhere, ETFs, in my opinion, standardized a lot of things. So whether you want oil futures, triple leverage queues, Vanguard, ETFs all serve up all this stuff in a way that feels the same and fits into anywhere, it’s almost like a USB port in a way, and so I think the technology and the low cost are what drive millennials to ETFs

Clay Finck (07:29):

The first part of what you said definitely rang true with me where, I have my baseline index fund portfolio that’s the foundation of my portfolio, and then I have fun with things like Bitcoin and maybe some individual stocks as well, but I’ve been listening to The Investor’s Podcast and We Study Billionaires for years and they follow the Warren Buffet philosophy of buy and hold for a very long time. So I’m really not a trader at all.

Eric Balchunas (07:54):

So you’re not trading per se, but you are adding on some speculative assets on top. My metaphor with that is you’re adding hot sauce onto the most healthy meal ever. Because you want to spice it up a little but you don’t just want the green vegetables. We want a little something to make it a little more interesting and the possibility of huge upside, you don’t want to not participate if Bitcoin does go to $200,000. It’s a beautiful thing, this way you get to have your cake and eat it too, and I think that’s what people are finding.

Clay Finck (08:20):

We talk a little bit about individual stock picking on our show, and a lot of investors might just decide that stock picking is just too complicated for them and it’s not something they want to do, they don’t want to be an active investor. Then they might dive into the world of ETFs and discover that there are just what feels like countless options in that realm as well. So how can investors go about narrowing down their selection of ETFs to put together a diversified portfolio that suits their needs?

Eric Balchunas (08:46):

Yeah, there’s 2,600 ETFs last time I counted, it’s a little overwhelming, there’s 12 blockchain ETFs. So first I think top down, think about your portfolio like a pizza pie or a pie chart. How much do you want in equities? How much in bonds? That’s actually the most consequential decision you can make. Once you get to the asset class, what you pick in there isn’t as consequential, it’s more important how much you want at the asset allocation level. So if you say 80% stocks, 20% bonds, once you get into the 80%, obviously a lot of people just buy say the Vanguard 500 or the iShares 500 ETF or three basis points to you own all the large caps, or even better, why not buy the total market ETF.

Eric Balchunas (09:26):

ITOT and BTI or two popular ones, they hold 4,000 stocks, they charge 0.03%, and you put that in your 80% or your 60% and you’re pretty good. And then on the bond side, the same thing exists with the aggregate bond ETFs, the BNAG a lot of people… That’s essentially like called the 60/40, but I guess the millennial might be higher on the 60, maybe 80. Bonds are actually pretty good, not this year, but as offers sometimes but it’s your choice, maybe you don’t want bond, but you have to decide that first. And then obviously I think looking at something very cheap and popular, Vanguard, BlackRock, or Spider diversified broad market ETF probably makes sense.

Eric Balchunas (10:01):

Then now that’s covered, that’s the easy part, what to put on top and if you’re an older person, you might want a ETF to reduces income. So what do you do? Do you go to like a dividend grower ETF or a dividend income ETF? Do you go after the high dividend payers, maybe? It’s a tough call because you have to weigh those different risks. And then if you want a blockchain ETF, do you go to one of the more popular companies or what are the newer ones that’s more in the crypto world. Some have less holdings than others, some are going to own… I think they probably all own micro strategy, but they’re going to own different stocks. And I think my main point on that is once you decide on a theme to play or income or whatever you’re looking for, get a list of ETFs that are in that and just look at the holdings. I mean, you can’t go wrong there because all the ETF is what’s in the portfolio.

Eric Balchunas (10:47):

Of the things that I recommend looking at are standard deviation because standard deviation is such a great metric. What you want to do is look at the standard deviation of like S&P 500 Spy. I don’t know what it is, maybe it’s 10%, 12%. That standard deviation is just telling you likely how much it’s going to go up or down in a year. So 12 percent’s giving an idea. It’s almost like the ski slopes, green, blue, or black diamond, and then look at what you’re buying. So if yours says 25 and you know the S&P is 12, it gives you an idea for how bumpy the ride will be. And same with bonds, some bond funds might be 2, 3, 4, and that gives you idea oh good this is going to be nice and stable. Standard deviation is a very classic and just powerful, you need to know that. So the holdings and that, and maybe you could look at the waiting, oh, that’s getting to next level, is it market cap weighted level waiting? Which gives the biggest stocks, the most waiting or equal waiting. Some ETFs wait by the amount of dividend that this stock throws off or they’re fundamentally weighted.

Eric Balchunas (11:40):

So there’s all different kinds of weighting schemes but I think largely the standard deviation is almost more important because that’s going to tell you… An equal weight at ETF would be more volatile, because it gives more weight for the smaller stocks. Again, the standard deviation you can’t hide from that, that field. And I would also look at the expense issue, obviously for the core you want very cheap. For your total market you don’t pay more than six, seven basis points, but for an outer layer, usually those costs a little more because their return can be much higher, but I would also consider fee out there. Like in the blockchain ETS, they probably range from 95 to 65. But again, when you’re talking about a handful of stocks and a lot of volatility, the holdings become more important than the fee because one could be up 20% and one up 10. Well that totally dwarfs the 30 fifths you saved on the cheap one.

Eric Balchunas (12:26):

So you want to really highlight fees in the core, but then you want to highlight what the holdings are on the outer layer stuff. That would be my advice, even though I don’t really give investment advice, but that would be my advice on sort of like how to think about approaching an ETF portfolio.

Clay Finck (12:40):

Let’s transition to talk more specifically about your book, The Bogle Effect, how John Bogle and Vanguard turned Wall Street inside out and saved investors trillions. I was personally very impressed with how deep into the subject you ended up going on the topic. What was your motivation for writing this piece?

Eric Balchunas (13:00):

Well, first of all, I had spent a couple hours with him in different interviews before he passed away so I had a bunch of hours of interviews. Anyway, he said some pretty prophetic stuff in this last interview in particular, and I thought, Man, I should get this on paper, not every day do you hang out with somebody that has such a consequence?” I thought it would nod me, and that’s when you know you should write about it, when it’s going to nod you and you should going to get it out of your system. But then I also have to ask, do I want to live on planet Bogle for two years? Because when you write a book, it’s like you’re moving away for a while and you’re going to live in this foreign place. And I thought, “Yeah, this guy had a lot to say he was smart. I certainly wouldn’t lose knowledge learning about this.” But in effect I gained a lot of knowledge and I’m happy I did it, but keep tiring studying the same thing over and over.

Eric Balchunas (13:38):

But what I did to try to break it up a little was, I interviewed 50 people who knew him, work with him, criticize him, and I got to hear everything they had to say. So all that was like studying for the CFA exam but for Bogle, for two years straight. So I don’t have the CFA, I don’t have an MBA, but I really talk to people and I find I get a lot of knowledge from alternative methods. And writing a book honestly, it is right up there in ways to get knowledge, because it forces you to know what you’re writing. And sometimes I knew it, sometimes I had to learn it and I read a bunch of his books, that was what motivated me. And I also, as an analyst, I get to see the flow numbers every day and all the time and I’m just stunned at how much Vanguard takes in.

Eric Balchunas (14:16):

They take in one billion dollars a day for the past 10 years. 10 years, a billion a day, that is so astonishing, we take it for granted, but it’s ridiculous. And if you take all the other asset managers combined over those 10 years, they basically net out to nothing. So this firm is massive and I thought this needs to be deconstructed a little more plus they’re private so nobody in my research department covered them, because they only cover public stocks like BlackRock and Golden Sachs, and I was like, “I should get this on paper.” And then also the final thing was, Vanguard is getting into different things, so they do ESG, they do themes, they don’t do themes, but they’re forcing people to use themes for that reason I mentioned earlier.

Eric Balchunas (14:54):

They’re also into a wealth management business, they have a trading platform, the behavior of investors has largely been influenced by Bogle and Vanguard. Vanguard allowed me a vehicle to really almost zoom down into these different worlds of Wall Street and explain what’s going on and how it’s being reformed as we speak by Vanguard. And obviously they’re not the only people doing it, but Vanguard, it seems like a book about funds but as you read, it’s about all aspects of the market. I even talk about Robin hood and some of the recent stuff we saw with the Meme stock craze. I talk about ESG themes, a lot of the things that are in front of mine today, but the most important thing is that this company is going to seriously reshape the future. I mean, they already have, but it’s going to get bigger and bigger, and I felt between the interviews and that data, I had to capture it.

Clay Finck (15:44):

I found the story of how Vanguard was created pretty interesting. It’s almost a story similar to what happened to Steve Jobs, where he was ousted out of his own company. Could you talk about that story for us today of how Vanguard was initially created?

Eric Balchunas (16:00):

Bogle is known as Saint Jack by a lot of people, but there’s a lot of circumstance played a role here, and back in the sixties, he ran a company called Wellington, which was an active manager. He was in the middle of the active management business and the problem was he was selling conservative active funds in an era where the sixties, everything was going up like crazy. It was like two years ago, when all the arc stocks like Peloton were just flying up higher and he was losing investors to companies like Arc at time. So he thought, “Well, if I’m selling bagels, nutritious bagels and the shopper across the street is selling donuts and everybody wants donuts, I should sell donuts too.” He partnered up with a growth manager and that partnership worked well for a while, but then it blew up when the sixties completely collapsed culturally and economically, and the market went down to think about 40-50% in two years, it was nasty, the 2008 style.

Eric Balchunas (16:50):

And they had a falling out, because Bogle thought these gun slingers ruined his conservative company, and they thought he was like an old man, whatever, not old, he wasn’t old yet, but it’s sort of too rigid. And they had a fight and the partnership was such that his new partners could actually fire him because they had voting control. So they fired him. What they didn’t realize is that he was still chairman of the funds themselves, which they didn’t realize, but it’s getting wonky here. But what I will say is a mutual fund is like a general contractor and they hire the investment advisor, they hire the administrator. So Bogle was still chairman of those 11 funds and he used that power that he had to come up with a deal.

Eric Balchunas (17:29):

And the deal was that everybody could agree on was, “Look, I’ll let you guys invest, you stay over here invest you like doing that anyway, I’ll do the back office work, the administration, the accounting. And this fund company we’re going to set up will be mutually owned, where the funds will own the company, that way it doesn’t look like I’m just trying to get a payday here.” So he had to sell to the board why he should stay on, run this company. And so by this weird situation, I can’t tell you how rare and almost unheard of a mutually owned fund company is, where the funds own the company, meaning the investors own the funds. Once you set that up, it means that all future profits are not yours. Think about that, you will never become a billionaire, it’s over.

Eric Balchunas (18:09):

You have to just take the salary the company gives you and be happy with that, and nobody since has done it because who would? But he was in this prickly situation and it was a way to get out of it, but once he locked into what this could do to the fund world, he became a evangelist towards this ownership structure, which anytime it gets assets in the investors are the owners so they vote to lower the fee with the profits instead of taking it. Because if the investors own the company, clearly they’re going to do what’s in their best interest, which Bogle really stressed is serving one master instead of two, the investors run things, there’s only one master the investor. Every other type of structure, whether it’s an LP, private LP or a shareholder on company, you have two masters, the investors want returns, the people who own the company also want returns and part of their returns come from their fees. That tension exists, I didn’t try to judge asset managers and say like, everybody’s bad who does this? But there is an inherent tension that Bogle solved, but what he sacrificed was ever becoming filthy rich,

Clay Finck (19:09):

It just reminds me of concepts Jim Collins has called the flywheel effect. We here at TIP love studying Jim Collins in his work, and he has this idea, the flywheel effect from his book, Good To Great. It essentially lays out this phenomenon where a little bit of success attracts more success and creates this flywheel that is extremely difficult for competitors to disrupt. You see this concept with many great businesses, you got Google, Amazon and all these big tech companies and the same thing with Vanguard, and for Vanguard it’s they lower the fees and them lowering fees ends up attracting more capital to their company, and since they’re able to spread out the expenses over more investors, they’re able to lower their fees even more. So it’s just a virtuous cycle that, it’s essentially impossible to compete with them.

Eric Balchunas (19:55):

So I will is a perfect way to put, I usually call it the upward spiral, but same difference, it starts to feed on itself and he knew that because… It’s funny because there’s a story Bogle tells in 1973, before he was the head of Capital Group for breakfast at an airport, and the head of Capital Group, which is a big active mutual fund company said, “I heard you set up a mutually owned fun company?” And he said, “Yeah.” And he goes, “If you do that, you’re going to destroy this industry.” Because he knew the flywheel and the upward spiral that would happen and the fees would get lower and lower the more assets come in, and then more assets would come in, which is exactly what happened. And what’s fascinating about that story, why I focused on the book is that was a year before the index fund was ever filed or registered by Vanguard.

Eric Balchunas (20:35):

In other words, the structure is the thing, the index fund was a nice byproduct and a perfect match for that structure, but anything that structure did was going to work because it was going to end up lowering fees. And you lower fees and asset management, usually the investors do better. Fees can really get in the way of returns, but people do need to get paid, and so I have a whole thing in the book about how fees aren’t bad if you’re starting out, if you run 10 million dollars, you kind of need to charge like 1% to keep the lights on higher people. What the problem was for active funds in the eighties and nineties is they got to be 30 billion, 40 billion, 100 billion, 200 billion and they kept the 80 basis point fee, they never… So you’re making 75 times more dollar fees, but the fees still seem small to every investor in the fund, which is 80 basis points, but dollar fees to me are one of the most underreported stories, but it doesn’t matter.

Eric Balchunas (21:25):

Investors sniffed it out by realizing, “Wait, Vanguard actually charges 10 or five. You charge a 80, I’m moving over.” But I think Active did themselves a disservice by not sharing some of those economies to scale. They didn’t even need to go as far as Vanguard, they could have shared just a little, and lowered their fees, bank some goodwill and their outperformance rates would’ve been better. So it is a classic business story also of the Steve Jobs rule, which is if you don’t cannibalize yourself, somebody else will. And they didn’t do any cannibalizing of themselves over the years when they really could have, they had a lot of gravy. And so I do write about why they were disrupted, and I do it gently, some of these firms are clients, some are adapting and I probably would’ve done the same thing and I say that like, “I probably wouldn’t lowered the fees myself, I would’ve sponsored a sports stadium, I would’ve hired a bunch of people, got a shiny new office.” It’s human nature, but that’s why the books about this other guy.

Clay Finck (22:16):

Yeah, he truly revolutionized the industry. One of the ideas that stuck out to me in the book was Vanguard offered this extremely low cost index fund because they wanted to, and that led to all these other companies having to lower their fees because they saw all these assets going to Vanguard. So Vanguard offered these products that had low fees because they wanted to, whereas the other competitors, they were just forced to bring them down.

Eric Balchunas (22:41):

Yeah, and that mattered to a lot of people, I think people can sniff that kind of thing out. That said, the people who lowered them, they swallowed their pride and said, “Okay, we’ve got to get into this business.” Some of those companies are very well run, like BlackRock and Fidelity and they have customers who like them. So in a way, as Bogle said, if they have to be forced kicking and screaming, there’s a lot of social work from them doing that. And this is also part of why I wanted to write the book is that, I just talked about Vanguard taking in the money, but most of the rest goes into Vanguard funds that people just basically were forced to create because of them, and that explains almost all the money invested in America today. In a way, even though nobody else copied the mutual ownership structure, they are governed by it in a way.

Eric Balchunas (23:21):

This is what Bogle did, and Bogle went even further in one of his quotes, which I didn’t even know until I researched this project was, he said that, “We’ll know Vanguard’s mission has begun to create a better world for investors when our market share starts to erode.” And again, I found that really wild because can you find anywhere else in the history of asset management, if not business, where the CEO tells the staff our market share eroding would be good and it would create a better world? And that I think speaks a different trip he was on, this guy was not out to do what most people do in capitalism, which is to make a lot of money. He was just out to do something different and it’s fascinating, and the thing is Vanguard’s market share is not going to erode for a while. It will eventually, but it’s still on its own, this hockey stick trajectory up. So his dream is really far from even being realized, let alone over.

Clay Finck (24:10):

Yeah, that reminds me of a stat you mentioned in the book where Vanguard currently has 29% market share in assets yet they only bring in 5% of the revenues and that stat alone is just very telling. And I want to talk a little bit more about John Bogle, and the forward for your book, Matt Hugin calls, Bogle a personal hero of his and in the intro of your book, there’s a Warren Buffet quote. It says, “If a statue is ever created to honor the person who has done the most for American investors, the hands down choice should be John Bogle.” Now why has Bogle been so monumental to everyday retail investors and what might some people miss about the impact he made?

Eric Balchunas (24:51):

So over the 45 year period that Vanguards existed, I come up with about a trillion dollars that they have saved investors. That’s not how much money Vanguard has taken in or has moved. That’s how much revenue would be in Wall Street versus in an investor’s pocket. That is a stunning amount of money so you could argue he was the greatest philanthropist ever, just for that effort. And people know this, I’m not inventing, I didn’t uncover Bogle out of… He wasn’t hiding. People may have heard of them, but I will say it was a millennial publication that gave me somewhat of the motivation to write the book. Because I wrote a story for Bloomberg opinion about how the money savings, I did the calculations to get to that number. Then somebody from Deadspin wrote a piece about my piece with a much more millennial type style.

Eric Balchunas (25:37):

And then someone from the billfold, which is a millennial publication basically wrote about that, and their headline was, some guy you’ve never heard of saved this all billions of dollars, which kind of sounds like a Buzzfeed headline. And this some guy I thought, “Okay, well clearly maybe the younger generation doesn’t know and it’s a good story and it’s a timeless story. This story, it’s captured, it will last, hopefully it will inspire younger people as well.” But I had to get over the fact and I was challenged by the fact people did know who he was, a lot of people in the industry, especially. So I went above and beyond with data and I went above and beyond by interviewing so many people who could put their 2 cents in, and all of the interviews you read are exclusive interviews I did for the book.

Eric Balchunas (26:19):

I had to interview somebody for an hour, listen to it back on the recorder, take say two pages, the best quotes, and then pick the three best quotes from those two pages. So you’re seeing the best stuff out of 50, 60 hours of interviews, and I did that because I’m trying to really bring to life something and offer something new to a story that is somewhat known. But that’s, I hope of what to accomplish, but I do think it’s interesting to read a book about somebody on Wall Street who did something good also, because most of the stuff you see and read in the movies is the Wolf of Wall Street, Wall Street Gordon Gekko, The Big Short, it’s a lot of people just trying to actually rip off small investors, or they blow themselves up. This is probably the biggest and best happy ending of the Wall Street story. But that’s also a challenge because people like dirt and juice, and there’s not a ton of that in the here, I try my best to give conflict and stuff, but there is no destruction or fall in the end, but hopefully the amount of impact that I’m able to capture and all of those interviews helps offset that.

Clay Finck (27:20):

Yeah, I think what you’re getting at is just people came around to really trust him and trust Vanguard. He’s dealing with people’s real money and there’s almost this stigma, like you mentioned around wall street in society, that they’re just out there to take your money and this has led to many people, sadly just completely avoiding the stock market. I agree that he has made just a tremendous impact on the financial sector that many people don’t appreciate, and it kind of reminds me of Buffet, how people would invest fortunes with him because not only was he a genius, many of the investors would bet their life savings on Berkshire stock because they knew they could trust Buffet and Monger and the board, and I think something similar applies here to Bogle.

Eric Balchunas (28:01):

Yeah, and you bring up the word trust and I get asked this question a lot from people they’re like, “Well, why is Vanguard still taking in a billion a day when all these other companies have low cost index funds?” And some of them by the way, have gotten cheaper bank of New York has zero fee total market ETFs these days, it’s only three basis points cheaper, but Vanguard isn’t the cheapest anymore. Even Fidelity offers cheaper index funds, remember that Billy Joel’s song called It’s A Matter Of Trust and I keep thinking of that when I think of the answer, because trust is huge. Trust takes a long time to build, whether it’s a company or a relationship, but it’s built over time and people have so much trust for this company.

Eric Balchunas (28:36):

They are boy scouts, I think, and seen as just very honest and trustworthy and especially when Bogle led it and he frequently called all the investors, honest to God, real human beings with souls. And he wanted Vanguard to stick to that and remember that these people are all actual people it’s not just a bunch of numbers. And that’s something that Vanguard has challenged with today, there are now 30 million investors, 8 trillion, and there’s been some complaints about the customer service that they have is not as efficient. And Bogle feared this, he feared it getting so big that it become like a bureaucracy where people wouldn’t have that connection with the investor base. That said, Vanguard has so much trust built up they can withstand a little bit of an issue here or there and it’s still a very sturdy foundation. Which by the way, what’s interesting about Vanguard is 97% of the assets that are in Vanguard came after Bogle stepped down as CEO.

Eric Balchunas (29:27):

This guy built a foundation that is so sturdy, and that’s what also I thought was fascinating is, I think is 87% of Apple’s market cap came after Steve Jobs left. There are cases of very visionary people who do all what they do and then it just takes off, like that flywheel effect that you mentioned, but the foundation is hugely strong. But it doesn’t mean it can’t change, and Bogle and many of his books said, “Vanguard is the fourth company to be the leader in the fund industry by market share, and the three others thought they were going to be around for a while too and they fell from grace, how we make sure Vanguard doesn’t do that? And these two big things are, we don’t really focus on active funds we just give you the market therefore you can depend on that, that’s different than buying into a hot active manager. The second thing was the treatment of, and seeing the investors as human beings and acting that way.” Those two things he thought, “As long as we do that, we’ll be good.”

Clay Finck (30:22):

What do you think drove Bogle to operate the business the way he did? He certainly didn’t do it for the money so I’m curious what your thoughts are around what drove him to set up the company the way he did in that mutual structure.

Eric Balchunas (30:35):

I asked everybody that question and everybody’s answer was, “That’s a good question.” Because again, it’s just notable to turn over all the future profits and then make the whole career out of saying, “This is the way to go.” So I have a chapter called Explaining Bogle, where I try to break down the ingredients that would make this person and there’s a couple things I think that are important. One, he grew up in the great depression, he knows what it’s like not to have anything. He’s also the World War II generation, which was like, I’m remember my grandmother, she didn’t throw anything away, like Sprite cans in her closet or you couldn’t even see the Sprite label anymore, but she would not throw them away. Bogle, I was told by his son wore the same Khakis for 50 years.

Eric Balchunas (31:08):

So he was just a guy who saved and didn’t spend and that’s a classic World War II generation, he’s not a boomer. So I think the great depression helped, his great-grandfather was also a antagonist and populist, and he wrote about the fireman’s insurance in the late 18 hundreds and he sounded a lot like Bogle so there’s a little DNA involved. I also thought that the sixties, that period I mentioned where he took the bait of the high flying growth era and tried to sell donuts, and when it blew up in his face he thought, “I’m never selling donuts again.” So real life experience is almost better than like anything you can read if you feel it, go through it. And that happened early. He was in his early forties when he set up Vanguard.

Eric Balchunas (31:48):

So he had that good lesson of don’t take the market bait these are cycles, just stick to the bagels. And I think that was important and I also think Princeton obviously, was a great university for him, but the other thing is his heart. Here’s a guy who was told he wouldn’t live past age 35, he had a very bad heart, had to go to the hospital constantly, when he played squash and rack ball, they would bring a defibrillator onto the court with him just in case he passed out. He had had a heart transplant later in life in the nineties. And so this guy was always… Death was always lingering and I think it actually motivated him to have a purposeful life in a way. And then I also think things like, he was a big Bible guy, not that he was hardcore, but he loved the text, the text is a lot about the underdog eating the big guy.

Eric Balchunas (32:33):

And he always ring up that quote of the cornerstone, and the rejective stone becomes the capstone, and he loved the stories in the Bible. Although he wasn’t heavy handed religion, but he loved the stories and I think he felt he was a character in that book, to be honest with you. I think he literally got a lot of that and he also is a fan of poetry, old poetry in the 18th century. So I think he almost like… There’s that phrase, “Make your life like the own movie you want to see.” And I think he did a lot of that, and I think this mutual ownership structure gave him such a sense of purpose and it filled a lot of what he needed, and what he needed wasn’t money, it was this. And I think that’s really what drove him, again, that’s unusual for this industry.

Clay Finck (33:10):

I love it. The rise in the assets under management for Vanguard over the years is just astonishing. They started in 1975, they hit a trillion dollars in AUM in 2006, and today their assets sit at around 7.2 trillion. And it makes me wonder if you’ve studied the idea if there is an index fund bubble, we have these trillions of dollars flowing in an index funds, these people are buying every month, regardless of the prices of these stocks that are in the funds. So I’m curious what your general thoughts are on that idea.

Eric Balchunas (33:42):

So I try to break this down in a chapter eight, called “some worry” with quotes, because some are worrying and I think most of it’s meaningless. Look, at the end of the day, all that’s really happened over the past 20 years is people went from buying an active, let’s say fidelity fund, that owns the popular stocks, but maybe in waitings that are slightly different than the benchmark, but you’re still owning JP Morgan and Apple and Amazon and AT and T, we call that closet indexing where you’re pretty close to the indexing, we charge 70 bits. All that’s happened is people are going from closet indexing to actual indexing, so they’re just owning all those stocks for three basis points. The metaphor I use is the CD to the MP3, I think indexing and ETFs are similar to the MP3, they’re just way cheaper and more flexible to get the same thing.

Eric Balchunas (34:27):

It’s not like indexing has invented stock investing just like the MP3 didn’t invent music, you’re just buying whatever music you like in a better way, cheaper way, it’s a format change. That said, index funds do buy stocks indiscriminately, if the stock has a higher market cap, it’s going to buy it more because that’s where it sits in the index. The market cap though is a term by active managers, and that’s why the S&P 500 can have a stock like Macy’s fall out of it and Tesla comes into it. The reason Tesla got into it is because active managers like Tesla, and the reason Macy’s fell is because active managers hated Tesla, active controls what’s in the indexes. So in the indexes, you are somewhat riding the coattails of active, but they are definitely dictating pricing.

Eric Balchunas (35:09):

That said, let’s say a stock like GE, which went to the gutter in early 2018 I believe it was, went down 50% in half a year because the bad earnings report, and then ETFs and index funds, the LG took in a ton of money during that period, but it still went down 50%. Now, would it have gone down 52% if it wasn’t for those bids coming in from the index fund flows? Maybe. So I think if anything, index and the rise of indexing might put a little bit of a baseline on stock sell ops because there’s a bid coming in. But overall, I think anybody over the past couple years can see with Meme stocks and Tesla and Peloton, that indexing is not controlling prices here, otherwise we wouldn’t see some of these stocks go up and down. So until we stop seeing that, I’m fine with this, indexing is a great way for people to get the value.

Eric Balchunas (35:53):

Also keep in mind, indexing is not uniform, the S&P 500 actually has criteria to get in, there’s a human committee that has absolute discretion over it. That’s why Tesla is late to get in, and then the Russell 1000 has their rules. Then there’s like, “Oh, I’m going to own maybe a total market.” That’s different, and then there’s different indices within midcap and small cap. And then you get to international, now some hold China, some don’t. Indexing isn’t really all uniform either, just like active isn’t that active either. So in the book, I try to explain to people that the real trend here isn’t active to passive because some active is very passive and some passive funds are pretty activ-ish. It’s not broker to RAA, which is also another big trend, and it’s not mutual fund to ETF, which is a trend, it’s high cost to low cost.

Eric Balchunas (36:38):

Within every one of those categories you just see people… I call it the great cost migration. So I try to explain that, that’s really what’s happened here. Also one of those stats that I think your listeners will like is that if you take the last 10 years, people are like, “Oh, well, passive equity index, mutual funds and ETFs took in 2 trillion in assets.” And some people even say, “They’re creating a stock market bubble.” I’m like, “Dude, the stock market grew by 43 trillion over those 10 years, there are many other forces of play here, households, institutions, hedge funds, foreign investors, ETFs and index funds, or quote ‘passive’ own about 17% of the stock market, so they’re still a minority owner, households own 40% of the stock market.” Again, there’s plenty of things going on, and the other thing is a lot of times people say, “Oh, well, indexing ETFs distort the market, they distort things.”

Eric Balchunas (37:28):

I think distorted is the natural state of the market, because then those people will also say, “Well, the fed is distorting the market. Or options, “The rise of options to trading by Robinhood people is distorting the market.” So distorting the market has now become the way active managers escape their under-performance or frustration with how things are going. Because going back I had this guy, who’s a history buff that I interview, this distorting thing and claims of distortion has been going on since the market started. It’s just the way it goes, people always think it’s distorted, they always worry. And so I don’t know, I think most of it is way overblown from parties that might feel a little threatened by this potential trend, or this trend.

Clay Finck (38:07):

You mention a ton of great points there and I can’t help but think of recently, Facebook and Netflix will miss earnings, and they’ll go down 20 or 25%. And that’s not like the ETFs are just dumping their Facebook and Netflix shares it’s because these active traders and these algorithms. It’s hard to say that ETFs have this just massive impact on the market. When you see these 20, 25% fluctuations, and you mentioned one big chunk of Vanguard’s AUM and that is their advisory business, which I don’t think a lot of people know about. I personally didn’t know a lot about it before reading your book. How has Vanguard helped transform this industry in particular?

Eric Balchunas (38:45):

Well, it’s just beginning. They’re where Vanguard was in the eighties for mutual funds. They just started it five, six years ago, and they really started it because there used to be… You had to go find Vanguard on your own, so you went as an individual investor and started investing with Vanguard do it your self style. Those people are now pretty wealthy, they’re boomers, they’re older, even though millennials like Vanguard too, there’s still those early investors are wealthy they need help now, with estate planning and taxes and this stuff. So Vanguard’s like, “Okay, well why don’t we create wealth management for them?” So it was originally created to help the Vanguard mutual fund investors that were already there, but the good thing is and the reason I think it will grow is that it charges a fraction of what a normal advisor charges and you get a certified financial planner.

Eric Balchunas (39:26):

So you get a human investor, it’s not a robo it’s actual advice and planning. I wouldn’t say it’s the level of advice and planning that some very mega wealthy people will get from their own personal advisor, it’s not that level. It’s a little more widget, but it’s still powerful because it charges between five and 30 basis points. An advisor, they’re more like 80 to a 100 basis points. So they have 300 billion about in assets, they have 1000 certified financial planners already employed there, and as we know the more assets they get, they’re going to lower the fees because that’s just how they roll. I have no reason to believe that Vanguard won’t impact a big chunk of the advisory business, which ironically, a lot of advisors are really helped force and expedite the move out of active mutual funds into ETFs and mutual funds because they switch from getting paid by the mutual fund in form of a kickback or a commissioner or a load, to getting a percentage of the client assets, but the percentage they take is one percent.

Eric Balchunas (40:18):

So in a weird way, they’re kind of making a similar mistake that the active managers made in the eighties and nineties. As they get bigger and bigger, I would advise them to share those economies of scale now and create good will before the Vanguard effect hits them too. But I think there’s a good chunk of advisors that will get disrupted, and Vanguard isn’t alone, Schwab has an advisory business, and the Robo advisories like Betterment, I think really spearheaded a lot of this. A lot of younger people use Betterment for the same reason, they’re 20, 25 basis points and I think for most people that’s fine. I will say the one percent advisors, there’s going to always be a market for real high need wealthy people or people who are specialized, say they just service the bass fishermen of the world.

Eric Balchunas (40:55):

And if you can like get into one community or a local area or to a specialty, let’s say you’re really good at the tax part. Those people probably are going to do fine even with Vanguard in the picture. Vanguard doesn’t disrupt everybody, they just tend to disrupt anybody overcharging for an under delivering. And again, that’s why I call it The Bogle Effect and not rise of the index fund because this effect is not limited to index funds. And being an advisor, by the way, if you’re going to be a true advisor wealth manager to wealthy people, you can’t just have mutual funds and ETFs, you have to have private equity. And so Vanguard just partnered with private equity firm, imagine if they get into that business, they charge a lot over there. And then it’s possible they move to crypto, they keep denying. It actually wrote a bit saying they will be in crypto within 10 years, but the more they have to service very wealthy people who want things that are not just mutual funds, it’s going to push them into all these non Boglian places, and it’s going to get interesting. The wealth management isn’t just something to watch for the wealth management business, it’s where it’s going to push Vanguard. And again, that also inspired me writing the book because I wanted to try to explain to people, this is way bigger than the index fund.

Clay Finck (42:02):

You mentioned crypto and I’m pretty interested in Bitcoin in the cryptocurrency space. One of the big issues is that Coinbase and all these other companies are charging transaction fees in excess of say 1%, and I just think of Coinbase Vanguard’s going to eventually come out to year lunch, and if Vanguard doesn’t it’s going to be Fidelity or whoever else is ahead of the curve on that.

Eric Balchunas (42:25):

When the coin crowd saw that all the ETF people were so excited about the spot ETF, I think they felt like, “Oh, we’re about to rock the ETF world, all these funny duddy advisors and ETFs and this.” And I said, “Guys, be careful what you wish for.” The ETF world could very much rock the crypto world, at least the intermediaries, the intermediaries, the exchanges in particular are paid a lot. The fees are ridiculous, they’re almost, I would say, make stock brokers from the seventies jealous. Once you get a spot Bitcoin ETF and once the BlackRock’s and potentially the Vanguard’s come in and have a little price competition. In five or six years, what you’re going to have is a spot Bitcoin ETF, a spot crypto basket ETF, they’re going to charge up, my guess is they’ll get down to 30. Custody will keep it above 10, maybe 30, 40 basis points, and it will trade at a 0.01% spread and you’re can invite commission free.

Eric Balchunas (43:15):

So the trading cost is nothing and you pay 30 basis points for them to just take care of everything, that is going to sweep the country and that’s a powerful thing. And so the exchanges are going to get disrupted and the market makers who can keep that 0.01%, that’s important. Those market makers, I did a study that the crypto exchanges make four times the revenue that ETF market makers make for doing 136 the volume. Think about that, that’s how efficient lean and mean the ETF world is versus the crypto exchanges. That said, capitalism is a sport and it’s a great way to get new inventions, and the first to arrive should get rewarded. So to the people who are getting rich in crypto would set up the exchanges early, “Hey, look, that’s capitalism.”

Eric Balchunas (43:59):

I’m not blaming them, I’m just saying that compression… You’re going to get cost compression one way or the other. I think a spot Bitcoin ETF though, even though they want it because they don’t make the price go up and they love the idea that the Bitcoin ETF will open up all this advisor money because advisors tend to like that structure and advisors have 26 trillion assets. So even a 5% allocation is a ton of money, I still think if you’re intermediary crypto, I would fear the spot Bitcoin ETF. I mean, I’d like it because it probably will help the price go up a little bit because you’d have more people coming into crypto, but I would fear your margins because this is just what ETFs do.

Clay Finck (44:35):

For investors in Bitcoin, you would expect a Bitcoin ETF to be positive for Bitcoin in the crypto space, am I understanding you correctly there?

Eric Balchunas (44:43):

Eventually yeah, there’s a real problem with Gary Gensler, he wants to show I think, that he can put some regulation around the crypto exchanges. As my colleague, James Seyffart said, he’s holding the spot Bitcoin ETF hostage, but the SCC put out a proposal to change the definition of the word exchange, and if it goes through and they’re able to do this, crypto exchanges will instantly be under the SCC’s regulatory eyes. Once that happens, I think Gensler’s fine with the ETF. He just wants it all to be within the Gensler world, he wants to oversee everything. That we see maybe summer 2023, I don’t think all that needs to happen. My personal opinion is they should have proved it seven years ago because an ETF, honestly, if you’re worried about the exchanges, if a spot Bitcoin ETF is approved, obviously we just talked about how it would cause cost compression, which is good for investors.

Eric Balchunas (45:27):

The market makers who are big and have a lot of liquidity, they’re not going to mess with shady exchanges in order to make markets in crypto. So if you want to work and get those big time US market maker dollars on your exchange, you’re going to have to shape up. So it creates a natural police force by just approving the spot Bitcoin ETF, but I think the Gensler himself wants control, wants to check a box on his resume in order to… And that view is just something in the way, but I think if he pulled a hundred people, 98, 99 would say, “Yeah, a spot Bitcoin ETF makes a lot of sense.” And it certainly makes more sense than a futures Bitcoin ETF, which introduces 10 to 20% roll cost a year, which makes the crypto exchanges seem like child’s play in terms of cost.

Eric Balchunas (46:09):

This is the world we’re in, we’re all cheering it on, and I wear a shirt to the recent ETF conference that… I got it custom made, it says, “And still no spot Bitcoin ETF.” Because a lot of times on Twitter, we’ll see the SCC approved something like double leverage vixed futures ETF, and we’d be like, “And still no spot ETF.” Or we’ll see in Europe that they’re already in a fee war over Polka Dot ETPs. I haven’t even heard of some of the stuff they’re launching out in Europe, and obviously that phrase, and yet still no spot Bitcoin ETF. Because the products they approve and the gap of time keeps getting larger and larger, where that phrase makes more and more sense and comes up more and more often. And it’s a big deal for us, we read about it a lot and obviously we think this Bitcoin ETF category could be easily a 100 billion, 200 billion, pretty quickly.

Eric Balchunas (46:52):

A lot of money is at stake here. And then of course, there’s the race, if you’re an issuer and you’re out first, you’re an instant millionaire. It’s going to get crazy, I think we want them to approve three or four at once at least to give it a fair fight, but whoever’s out first wins. I mean, the future’s ETF pro shares had a, I don’t know, three or four day head start and they probably have 90% of the assets and volume. That’s why this is fun to cover, A, because of all the stuff at play, probably one of our top three topics that we cover because of all of the drama and what’s at stake, it’s endlessly fascinating.

Clay Finck (47:21):

Yeah. I constantly see the gray scale guys posting on Twitter saying that they’re pushing for the ETF, they’re pushing for the ETF while they’re charging a 2% fee and have a 25% discount on their net asset value. Now, even with Vanguard as big as they are today, I’m curious what your take is on the role of an actively managed fund. Bogle’s son was actually an active manager himself and he was actually supportive of him choosing that path, so what are your thoughts around the role and actively managed fund can play?

Eric Balchunas (47:50):

Bogle wasn’t necessarily anti-active, and I talked to John Bogle Jr, and he said that his father always said, “Good luck to you, it’s a tough business, but some people can succeed.” He never said active couldn’t succeed, he said as a group, it’s largely detracts from value, because only the costs are so much that they just eat up a lot of the return. And again, they’re all trading with each other so only some can win, and then when you X out costs, you see the majority of them lose after costs, that’s all Bogle was saying. I will say Bogle was proud of some of their active funds at Vanguard, Prime Cap is one and the Wellington fund, and he writes about them a lot. Although he doesn’t say like, “Oh, our active funds are so good because the manager has PhD.” Or, “This formula is so good.”

Eric Balchunas (48:31):

He really just raves on how the ownership structure was able to get their fees down low, and the fund doesn’t trade a lot. And by removing those costs, it lets the active fund have a better chance at success and it’s like bringing a gun to a knife fight in a way. And so that section, I call Bogle metrics because it almost seems like saber metrics where in Moneyball, the a list manager valued things like on base percentage more than batting average. So he didn’t look at the sexy stats, he looked at some of the ones over here and built a team of lower cost players, so I feel Bogle metrics is how Bogle saw active. At the end of the day, I think Bogle, because Vanguard does have plenty of active funds, what he was really about with stewardship and I think he felt some of the active funds weren’t good stewards in not sharing those economies of scale.

Eric Balchunas (49:15):

And that I think, he thought was the problem, not that they were active per se. And he also goes to great lengths, even though he is pretty savage, to say that, these are nice people, they’re smart people, that’s not their problem. The problem is they take too much out and costs and it’s like trying to start a race 200 yards behind the starting line, and you have to make that up just to get even with the runners. And that was his problem, and that is a problem. It’s not really disputable the math is there, it’s hard. So where I think active’s going to go now is, people are not going to use the active that takes little risks outside of the benchmark.

Eric Balchunas (49:52):

They’re just going to buy the benchmark in a cheap index fund, but what they’re going to look for is we talked about earlier is crazy high active share active like Arc or thematic investing, something that can compliment it. So active will still be there it’s just going to be a supporting player, I think in the portfolio, and it’s going to have to be very different. We actually have a theme we’re working on this year that says that active share, which is how different you are from the benchmark, is going to replace alpha as the most important metric for an active manager to show. And active share doesn’t necessarily mean alpha, and a lot of people steeped in studying this stuff are going to find that hard to swallow because alpha is supposed to be what you’re trying to get. I think institutions will still like alpha, but I think for the advisors and the portfolios that are passive, you’re going to prioritize how different you are because they want a lottery ticket, they want the chance at a home run in that outer layer.

Eric Balchunas (50:42):

They don’t want the same stocks put on top of the same stocks they own, but with, “Oh, you had some alpha in the past, let me try to get that and double up.” I just don’t think that’s going to happen. So active is not going away it’s just evolving, and honestly, it’s evolving because of what Bogle did, he’s forced it to become supportive and different. But honestly, if you’re an active manager and I talked to the guy from the Janus 20, which was a concentrate active fund that was like Arc back in the day, I’ve got to think that they might be more happy ultimately buying their 20, 30 best ideas. Instead of buying the index and should we overweight Amazon at 3 percent instead of two, honestly think that’s going to be more fun for them or offering up some private equity, or even crypto, crypto trading, NFT trading, I think active is going to find more fun and excitement away from that closet indexing active anyway. So it could be a win-win for everybody.

Clay Finck (51:32):

Are there any trends in the ETF space you’re looking at or any trends you’re excited about?

Eric Balchunas (51:39):

One of the things we found that we thought has a lot of value is, you’ve got dirt cheap and shiny objects, we know those are two viable lanes, but there’s a third lane opening, which is package trades, and this is where the SCC lacks rules where you can actually use derivatives more liberally in an ETF. So there’s a few companies, Simplify in particular comes to mind, that are able to use options, and futures, and derivatives and swaps in a way to really sculpt some interesting return streams and provide hedges, especially with the 60, 40, maybe both going down for a while because they both went up for a while. Some of these package trades that offer non-correlated returns, hedge fund type strategies, I think they’re going to find a home. I think that is a lane that could grow, and I think it also shows that the ETF industry isn’t just spy, it’s just a rapper, and you can put a lot of interesting things in that rapper.

Eric Balchunas (52:26):

And I think that outside of Bitcoin and crypto is probably the most interesting lane, which is using derivatives to sculpt return streams. There’s even an issue that has innovator buffer shares, where it says the first five percent of the loss is on you, but from five percent to 30, you don’t have to suffer. If it goes over 30, then you’re back on the hook and then it will do it up to 10 over 10. It basically, you’ve got all these ways to limit your downside, of course you have to limit a little upside too, but these kind of targeted outcomes are going to be interesting and I’m excited. That’s where a lot of the innovation’s happening.

Clay Finck (53:00):

That is very interesting. Now, Eric, thank you so much for joining me, I loved your book and I’m really glad you took the time to come onto the show today. Before we close out the episode, where can the audience go to connect with you and find out more about your new book?

Eric Balchunas (53:15):

Yeah, sure. First of all, thank you for having me, I had a great time talking to you. I guess you could go to Amazon to buy the book, that’s probably the easiest most direct way, but then to find me I’m on Twitter @ericbalchunas, believe it or not, that handle was not taken. Only a few people, anywhere I sign up for a social media account my name is totally available. And I think Twitter is probably the best place, I have my DMS open, I’m pretty available. I’ve had people from Rutgers where I went to college, reach out to ask for some career advice. I’ll sometimes answer a question there, sometimes I get some crazy to them, I’m just not replying to but that’s probably the best way to reach me. I also put out little sampler platter charts and stuff from our research so you get an idea of what I do.

Eric Balchunas (53:51):

Those will be the two places to find me, I will also plug my podcast, which is called Trillions, which is all about the ETF world, that’s anywhere that you can find podcasts. And I do a TV show with Matt Miller and Katie Grayfield called ETF IQ on Bloomberg TV every Monday at 1:00 PM. You can always go to ETF IQ on the internet and find all the past episodes. That’s a fun show cause it’s very aesthetic, we have graphics and we have cool guests. A lot of people who we have on become bigger deals later, like we had Kathy Wood on four or five years ago, that show… And it sculpted returns I just talked about, we had that guy on two days ago, the guy who runs Simplify. It’s a good show to get ahead of what’s happening because I always think ETFs are the Silicon Valley of the investing world and that’s how we cover them. So anyway, that’s how you can find me in the book and I’ll end the plug there, that’s plenty.

Clay Finck (54:38):

Awesome. Thank you so much, Eric.

Eric Balchunas (54:40):

Thank you.

Clay Finck (54:41):

All right, I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app so you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it if you left us a rating or review on the podcast app you’re on. This will really help us in the search algorithm so others can discover the show as well. And if you haven’t already done so, be sure to check out our website theinvestorspodcast.com, there you’ll find all of our episodes, some educational resources as well as our TIP finance tool that Robert and I use to manage our own stock portfolios. And with that, we’ll see you again next time.

Intro (55:18):

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