Why John Bogle is both gratified and terrified by Vanguard’s success

The runaway success of Vanguard Group Inc. over the past five years has, surprisingly, left its founder John Bogle with some ambivalent feelings. But he remains convinced that the index fund — his brainchild — cannot be improved upon.

Vanguard’s mutual fund and ETF assets have grown to $2 trillion, up from $1 trillion in 2008, and its share of the fund market has risen to 17.3% from 13%, as the firm’s low-cost philosophy has caught fire with advisers.

“There’s no question Vanguard’s taken over a huge role in the fund business,” Mr. Bogle said. “I see it with mixed emotions. When it’s taking in something like 70% of the industry’s cash flow I don’t know if I should be more gratified or terrified.”

At the heart of Vanguard’s success are index funds, which Mr. Bogle created in 1975.

“Our goal was to create middle of the road funds that you can invest in for a lifetime,” Mr. Bogle said. “How can you be a long-term investor if the fund doesn’t last for a long-term? Only one fund will guarantee the same portfolio manager 50 years from now as today, that’s the index fund. There is no portfolio manager.”

In contrast, the average actively managed mutual fund will see about five manager changes over a 50-year time horizon, Mr. Bogle said.

There’s been a $1 trillion swing between actively managed mutual funds and passively managed index funds since 2008. The former has seen around $600 billion of outflows, while the latter has taken in a staggering $400 billion.

Mr. Bogle’s not surprised that investors have finally latched onto the idea keeping investment costs low “It’s very clear that the index fund is the gold ingot,” he said. “There’s no way of improving on it. Not everyone can outperform so they’re consigned to the average minus a low-cost.”

Exchange-traded funds, the publicly traded sibling of index funds, have also played a huge role for Vanguard. Mr. Bogle was originally against the idea.

In 1992 — back when he was still CEO of Vanguard — Mr. Bogle was approached by Nathan Most, who wanted to turn the Vanguard 500 Index Fund (VFINX) into something that could be used by traders.

“He was a very nice man,” Mr. Bogle said. “I told him we didn’t want to turn it into something for traders. Two weeks later he went to Boston and sold the idea to State Street.”

That idea turned into the $136 billion SPDR S&P 500 ETF (SPY) and led to State Street Global Advisors becoming the second largest ETF provider in the world.

Vanguard, which entered the ETF business in 2001, five years after Mr. Bogle stepped down from the chief executive role, is currently the third largest ETF provider. The fund firm is gaining market share at an impressive clip by focusing more on buy and hold investors.

“In the ETF space we have not gone to the nut cakes,” Mr. Bogle said. “We’ve avoided traders.”

The other thing Vanguard has avoided: Thinking like other asset management firms. That’s due, in large part, to Mr. Bogle’s lead. He not only structured the company so it’s owned by the fund shareholders, he’s also had a unique take on marketing.

“Marketing is finding what people want and giving it to them. It’s fine if you’re selling a product, but I never looked at Vanguard as a product seller. I banned the use of the word product at Vanguard many, many years ago,” he said.

Mr. Bogle learned the perils of letting marketing lead his thinking early on. He’s always been opposed to the stable $1 net asset value on money market funds, for example — so much so that he launched a money market fund with a $10 NAV that floated.

“No one would touch it,” he said. “So I caved. Every time I’ve done something because of marketing, it’s ended up on the long list of things I shouldn’t have done. You have to think about the shareholder first.”