Video Reports

By Christine Benz | 10-04-2018

The Vanguard founder says low dividend yields, modest earnings growth potential, and still-low rates mean returns are set to be lower.

**Christine Benz: ** Hi, I'm Christine Benz for Morningstar.com. I'm at Vanguard headquarters to speak with Jack Bogle. He's the founder of the Vanguard Group.

Jack, thank you so much for being here.

**John C. Bogle: ** Always great to be with you, Christine.

**Benz: **Thank you for having me here, and I'm here for the Bogleheads conference. This is an annual event that honors you and your many contributions to the financial services industry. We've been doing these video interviews for several years now. It's kind of a tradition.

One thing I often ask you to talk about, because I think you have a very intuitive way of approaching it, is what you're expecting in terms of market returns for the equity and bond markets in the next decade?

**Bogle: **It hasn't changed from what we talked about last year very much. But there's a reality to the stock market--let's take that first. The reality is that the fundamental return, the dividend yield plus the earnings growth of companies, drives the long term return of the stock market. The only thing that gets in the way in the short term is a speculative** **return; are people going to pay more for stocks? Are people going to pay less for a dollar of earnings, in essence?

For example, if the price/earnings multiple were to go from 10 to 20 over a decade, that would be a 100% increase and be 7% added to the return each year, so it can be very substantial. And it also can be negative. If the P/E goes from 20 to 10, minus 7% or roughly 7% a year.

So where are we now?

The dividend yield is about 1.8%, less than 2%. I'm looking for future earnings growth of around 5%. I don't think we can do much better than that; maybe a lot better this year with the tax cut. Maybe a little bit better next year, too. But maybe 5%. So let's call the dividend yield 2, and 5 is 7.** **By my numbers, that's the investment return, 2% dividend yield, 5% earnings growth. That's a 7% return.

If the price/earnings ratio is to go down a little bit, I think 1.5% off that 7% return, which would be a 5.5% return on stocks over that period. That's a little higher than I've been using--maybe right, maybe wrong. I've usually been using about 4. But that's a ballpark. It doesn't really matter what we guess in these areas. There's no precision in any of this. Let's say in the 4% to 5% range is just for the fun of it, for stocks.

Bonds are a different matter, because there's only one driving factor for bonds in the long run, and that is the current level of interest rates. We use a combination of the 30-year Treasury, which is a little over 3%, and then we use 50% of that and 50% of the corporate rate, which is around 4.25%, and that's going to give you about a 3.8% let's say, but I'd round it to 4 ...

**Benz:** Blending those two together.

**Bogle:** ... on the return on bonds. So, 4% from bonds and a slightly higher percentage from stock. The point of this is not accuracy. I would not know how to do that, and anyone tells you they do know how to do it shouldn't be talking to you--you shouldn't be talking to them.

But rather that instead of the high returns over the last 25 years, or the market during Vanguard's history, the market's gone up 12% a year--I'm talking now stocks alone--if we get 5% in the years ahead ... just think about this for a minute.

At 12% a year, the market doubles in six years. At 5% a year, the market doubles in approximately 15 years. So basically over 15 years, you're going to get 4 times on your money if it's 12%, which it's not going to be. If it's four times a year, I hope all this makes sense, you're going to get the same number but it's going to take twice as many years.

**Benz:** And that's not even factoring in inflation or taxes or expenses ...

**Bogle:** Mutual fund costs.

**Benz:** I knew you would end up there.

**Bogle:** When you look at a combined market return of, say, stocks and bonds together, let's call it just for the fun of it 4%, I won't be far off--I don't want to do too many decimal points here--and the average mutual fund has expenses that come pretty close to 2%. Not just the expense ratio, which for actively managed mutual funds is now about 0.75, something like that, but you have sales loads for a lot of funds, and the funds that have dropped their sales loads have higher expense ratios. No way around that.

Then internal portfolio transaction charges; you don't see them, but they're there. Fund managers turn their portfolios over with a fury. Active managers, the turnover rate by my measure, is something like 100%; very, very high. I'm talking about purchases plus sales as a percentage of assets. The convention is to take the lower of purchases and sales ...

**Benz:** When calculating turnover.

**Bogle:** The cost is both sides of the transaction, not one. You're talking about 2% cost, and now you've taken the return down. Then you take inflation out, and let's assume that we're lucky to get 2% inflation, you've now got 4% off that return, 5% market return. What does this say? We can't do anything about inflation, but we can do something about fund costs, and that is keep them low. Period.

Which means, as you were about to say I'm sure, index funds should be at the top of your list.