Acquired
01:37:53 · Ben Gilbert, David Rosenthal
[01:37:53] S0: Right. They they went no load. They they refused to pay eight and a half percent to people outside the firm, but now they just have a fixed cost base that they picked up of people that work inside of Vanguard that have to do the work of not only convincing people to buy these funds, but then on top of that, actually handling and facilitating the purchase. The the way that this worked is you would communicate and send in an order via mail, and then you would mail a check to invest in this fund. [01:38:26] S1: Right? Could you imagine? I mean, I remember my parents doing this. [01:38:29] S0: Yes. So, you know, eliminating distribution. Sure. But somehow, someone has to do the marketing and distribution, and now you just do it in house. [01:38:36] S1: Yep. On the back of that, the 500 index fund does finally reach the 100,000,000 capital milestone in 1982, six years after launch. Takes them six years to get to a $100,000,000, which again, that was not large at this point in time. The Wellington Fund, many years earlier, had been $2,000,000,000. Yep. And the initial IPO target had been a $150,000,000, so they're still below that six years in. [01:39:04] S0: And they've got this headwind of they just switched away from paying people to do distribution. So there's now no incentive out there in the marketplace to try to sell Vanguard funds. [01:39:14] S1: Yep. Yep. But the slow burn does start, and towards the end of the decade in the nineteen eighties, by 1988, the fund reaches $1,000,000,000 in assets, and it would obviously grow from there.
01:39:14 · David Rosenthal, Ben Gilbert
[01:39:14] S1: Yep. Yep. But the slow burn does start, and towards the end of the decade in the nineteen eighties, by 1988, the fund reaches $1,000,000,000 in assets, and it would obviously grow from there. [01:39:25] S0: So that's six years to reach a 100,000,000 [01:39:28] S1: Yep. And then another [01:39:29] S0: six six years to get to a billion. [01:39:31] S1: Yep. That's right. Now you might be wondering, that's not a lot of capital, and Vanguard's fees are super low. How is the firm staying afloat during this period? Well, it turns out that Jack's first revolution of the low cost, low fee proposition of Vanguard, it works pretty well in equities. There are other financial markets out there where the low cost strategy works even better, specifically money markets and fixed income, aka bonds, the debt market. In equities, you can have real outperformance. There is uncapped upside to investing in equities. This is the dream that active management sells. Jerry Tsai or Peter Lynch or Warren Buffett or, you know, the greatest investors of all time, we can generate annual returns in the twenties, thirties, even higher percentages like Rentec in our episode there. If you're investing in the debt markets or the money markets, there is a ceiling to your performance. It is the coupons of government bonds or muni bonds or, you know, treasuries in the case of money markets. Yep. The only thing that matters in terms of relative investment performance by products offered in those spaces is costs. [01:40:54] S0: Yep. The lowest cost provider will win in those markets.
01:40:54 · Ben Gilbert, David Rosenthal
[01:40:54] S0: Yep. The lowest cost provider will win in those markets. [01:40:57] S1: And Vanguard builds a juggernaut in the fixed income business during this era, and that's what keeps the firm afloat while they are waiting and waiting and waiting for Jack's indexing revolution, his second revolution to come online. [01:41:15] S0: Well, there's that, and there's also the fact that John Neff, who managed the Windsor Fund, which was an actively managed fund and had the fees of an active managed fund, was absolutely shooting the lights out [01:41:31] S1: for equity side. Yes. I was wondering if you were gonna bring this up. That is the other deep irony here. Vanguard never got out of the active business. [01:41:40] S0: And they sort of inherited it by virtue of having some responsibilities for the Wellington funds that they shared with the Wellington management company. And so, yeah, this Windsor fund, there were many years where it basically provided all the profits to pay all the overhead and keep the lights on while Vanguard's low cost indexing strategy was On a slow burn. Scaled enough to pay for itself. [01:42:03] S1: Yep. Absolutely. And Vanguard today still has very large fixed income businesses, money market businesses, and active equities management businesses. But today, they're all dwarfed by the index fund business. [01:42:18] S0: Yep. Which wasn't the case for a long time. [01:42:20] S1: Yep.
01:42:20 · David Rosenthal, Ben Gilbert
[01:42:20] S1: Yep. [01:42:21] S0: You know, it's funny. You said something a couple minutes ago that I'm stewing on here. This whole in equities, a low cost index fund, in the long run, will outperform, you know, 85% or something of other actively managed funds. Listeners are probably wondering, is that really just fees? Is it just that having low fees makes you better than that much of the market? There are other components to it. A giant one is behavioral. If you are in a mindset where you are actively trying to pick the best companies Yep. You do a lot of trading. And aside from the fact that that has a lot of transaction costs, you tend to react to external stimuli, the market being up. [01:43:16] S1: You don't stay in your winners long enough. [01:43:17] S0: Market being down. You having conversations with other people. Exactly, David. You selling out of your winners too early. Whatever it is, and you can make the errors on either side. There's a behavioral component where passive index investors tend to not act, and what you need to do is not act for long periods of time to be a great investor. [01:43:38] S1: Yes. It's the great Warren Buffett line. Don't just do something. Stand there.
01:43:38 · David Rosenthal, Ben Gilbert
[01:43:38] S1: Yes. It's the great Warren Buffett line. Don't just do something. Stand there. [01:43:42] S0: Yes. Yes. Whether you are trying to shoot the lights out like Warren Buffett and you are active and trying to find the very best businesses you can or whether you are passive and sort of throwing your hands up. Either way, you need to mostly not act every day. And passive index investing just lends itself better behaviorally if if you're in one of those funds to just saying, I know the market's up. I know the market's down, but whatever. I own the index. I've I've made my piece. Whereas if you are either the active manager trying to improve the outcome of the fund or an investor in an active manager, both of you have a higher predisposition to do stuff. And for most investors in the long run, you shouldn't do stuff most of the time. [01:44:30] S1: Yep. Yep. Absolutely. So as we exit the eighties here, all the pieces are in place finally for the rise of indexing. The Vanguard five hundred fund crosses a billion, as we said in 1988, and then the model's working better and better. The scale economies are getting shared. [01:44:54] S0: Fees are coming down from that initial launch price of 68 basis points to in 1979, 59 basis points, then down to 50 basis points in 1985 to 35 basis points in 1987. We are really starting to be the true low cost index fund. They've already dropped by 50% here by the end of the eighties.
01:44:54 · Ben Gilbert, David Rosenthal
[01:44:54] S0: Fees are coming down from that initial launch price of 68 basis points to in 1979, 59 basis points, then down to 50 basis points in 1985 to 35 basis points in 1987. We are really starting to be the true low cost index fund. They've already dropped by 50% here by the end of the eighties. [01:45:16] S1: Yeah. Yeah. I mean, the scale economies are getting shared. Yep. Everybody around the table is eating good. So after assets crossed the billion dollar threshold in 1988, around nineteen ninety two ish, they hit $10,000,000,000. So, you know, 10 x in four, five years with strong acceleration. Also in 1992, Vanguard launches the sister fund, the total stock market index fund. They now have more than enough capital base that they can own every single stock. Why stop at the S and P five hundred? Own everything, all US stocks. [01:45:49] S0: And computers are sophisticated enough by this point in time where you can track the entire stock market and own the entire stock market and handle the reporting on that. Not to mention you have the benefit of not having to pay S and P Global a licensing fee [01:46:03] S1: Yes. Yes. [01:46:03] S0: Index the entire market. [01:46:07] S1: Quite convenient. You know? Look. They're not not business people at Vanguard. Right. [01:46:12] S0: Oh, they're great business [01:46:13] S1: people. Business people. [01:46:14] S0: It's just on your behalf instead of on shareholders' behalf.