Bogle Sets the Record Straight on ETFs

In case you missed it – John Bogle was recently criticized for supposedly stating that ETFs are bad for the investment world.  But Bogle’s comments were very specific.  Bogle doesn’t think ETFs are necessarily bad for the investment world.  He thinks they can be abused though and that many of the products that have come out in recent years are based on nothing more than a marketing pitch inside of a vehicle that sucks fees while failing to provide what it promises.  I think there’s a lot of truth to that view.

The following comments nicely summarize his views:

”  . . . I remain positive on the (ETF) concept, but only when (a) the right kinds of ETFs are used; and (b) used for investment and not speculation. I’m decidedly negative about the remarkable range of foolish extremes that have characterized their implementation.”

“ETFs have become a means for hedge funds to speculate on the market throughout the trading day . . . Like a hyperactive child, the finance sector can never let a good thing be . . .”

I’ve often described the ETF as the “greatest marketing innovation” of the fund industry so far in the twenty-first century. I stand by that statement….whether it is the greatest investment innovation remains to be seen.”

The ETF world provides investors (really savers) with options and flexibility.  Unfortunately, that flexibility is often abused or misunderstood.  While I agree with most of what Mr. Bogle says, I think he’s wrong that ETFs are not the greatest investment innovation of the 21st century.  Personally, I think ETFs will slowly kill off the mutual fund and hedge fund businesses as more and more people realize the greater fee efficiency, tax efficiency and general flexibility they provide.



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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. I’m with you on flexibility Cullen, but are they really more tax and fee efficient?… say more than the 0.06% management fee I pay for my Vanguard S&P 500 fund in my 401K? Vanguard in particular (I thought) uses their index mutual funds as a basis (somehow… I don’t understand this really) for their ETFs.

    Personally I played with the ETFs for a while (with a small amount of money) … doing all the things Bogle complains about here (and righly so), and then I got bored, and left my money in mutual funds. The flexibility was really the only thing that attracted me to the ETFs: I could buy or sell immediately if I wanted. But if that’s a motivator… you’ve got to question what you’re doing with that money anyway. For me it was clear: gambling. Personally (for my actual savings) I don’t mind having less flexibility if the fund is able to use that to pass along investment expense savings (e.g. many Vanguard funds have trading restrictions… you pay a fine, for example, if you trade more than once ever six months). That’s about all the flexibility I need if I can shave off a little more of the costs associated with fund turnover.

  2. Why would you buy the 500 mutual fund as opposed to the 500 ETF (VOO)? They’re the same thing except you have more liquidity with the VOO.

  3. Management fees: I just checked: The S&P 500 mutual fund I use is %0.02 management fees and VOO is 0.05%. Not a big difference, but if I only futz with it once a year at the most, I don’t need the flexibility, so why pay more?

  4. BTW, the Vanguard mutual fund is in “signal shares” (they have different grades with different management fees — signal is pretty low).

  5. Hey Tom. Good point. Those Vanguard mutual funds are good. In general though, mutual funds suck compared to ETFs. But I am generalizing. Just curious – does the Vanguard 500 fund spit out capital gains distributions?

  6. Yes it does. I always have them re-invested. Also, I should say that almost all my savings are in retirement funds. My company tries to match 25% of my base salary (sometimes they fall short a few % … and some of that is in company stock). On top of that I have the maximum taken out of my paycheck to go into my 401k, plus I max out on IRAs, and my HSA account every year (the compnay puts some into the HSA each year too). So I don’t really see the tax liability now.

  7. Does the ETF 500 fund perform the same as the mutual fund? Do they each own the same stocks in the same percentages at the same time?
    Does the 500 fund or ETF hold equal dollar amounts of all 500 companies?

    I wonder what would happen is we all held index funds. Don’t index funds need active managers to tell them how to build their portfolios … i.e., when Wal-Mart becomes a bigger part of the index, the fund buys more.

  8. Is there a tax advantage to non-retirement fund ETFs vs the underlying mutual fund it’s built on? (assuming it is)

  9. Lot of questions there:

    Does the ETF 500 fund perform the same as the mutual fund? – Yes, minus the management fees.

    Do they each own the same stocks in the same percentages at the same time? — Yes

    Does the 500 fund or ETF hold equal dollar amounts of all 500 companies? — No, they are meant to track the S&P 500 index which is weighted by market capitalization. So if Coke is a bigger % the market than Ford, they’ll own more Coke.

    Don’t index funds need active managers to tell them how to build their portfolios … i.e., when Wal-Mart becomes a bigger part of the index, the fund buys more. — No and Yes, that’s what happens, but the “active” part of that is so small they classify it as a “passive” fund. Again, they try to match the index, so mostly that means just holding the same stocks as the index in the same percentages (with some minor deviations).

    don’t know if this will come out, but here’s the prospectus:

  10. Thus if I had a $1M in VG S&P 500, then that’s what my $200 of management fees would pay for each year… for them to keep me tracking the S&P 500. :)

  11. Actually it surprises me how low that is! … last time I checked (a few years ago) it was 0.06%… three times as much! OUTRAGEOUS!!! haha … but seriously the idea of paying 1.5% for some “expert” management just makes me laugh…

  12. In a world where everyone invests through ETFs, how does capital get allocated? Who buys IPOs? Does private equity fill the void and incubate companies to greater maturity (e.g. Facebook)?

    I agree that ETFs will kill mutual funds. Just trying to think of the implications.

  13. Cullen: in theory, they have the same cap gains distributions as the ETFs; in practice, that means neverm since cap gains are disposed of on ETF sales as usual. Tom below is probably thinking of dividends.

    This is unique to Vanguard, they structure the ETF as a share class of the fund.

    I prefer the fund because of the lack of spreads / NAV weirdness. Others prefer the ETF because of intraday tradeability. Mostly, it doesn’t matter.

  14. You may be correct… I was going from memory there… seems to me that I’d get a statement at the end of the year with short term and long term capital gains. Do you suppose that only happened when I sold shares of the funds? I’m looking at a statement now with ST cap gain and LT cap gain on it.

    Also I see online that in December I received a Short-term capital gain that was reinvested… I’m positive I haven’t touched that fund in more than a year. It’s listed next to a dividend, under “transaction history”

    … and I see I have “Capital Gains” and “Dividends” set to “Reinveset” on the fund options … there are other options (like send me a check in the mail)

  15. Tom, the capital gain you see is a result of turnover within the fund itself. Vanguard funds tend to have lower turnover than most, but they still need to liquidate shares for a number of reasons, e.g. raise cash for shareholder redemption, or to better track their corresponding indices.

    I believe ETFs are advertised as more tax-efficient because unlike traditional open-ended mutual funds, they don’t need sell securities to accomodate shareholder redemptions. With Vanguard ETFs I think this is a moot point because they’re effectively a share class of an open-ended mutual fund. Someone with more investment (or saving) experience can probably explain it a little better.

  16. Tom: as far as I know VFINX has not distributed cap gains since VOO exists, and the same is true for the other index funds with ETF shares. I can only check back to 2008 right now. Perhaps the December distribution was from one of your other funds, and certainly you’ll receive gains caused by your own selling.

    Jake: the gist of it is that the ETFs can “give” the capital gains caused by turnover (which is low to begin with for index funds) to people selling ETF shares, by handing them the share lots with the lowest cost basis in-kind. By contrast, mutual funds have to sell inside the fund to meet redemptions. A weird artifact of the tax code for sure, but it’s a real effect.

  17. So that is a tax advantage for ETFs over mutual funds then? And you’re right, the VG fund I looked at with ST Cap gains is not the basis of an ETF.

  18. Yes, in the perfect world, (like Milton Friedman’s monetary policy) all of this would be handled by a computer at extremely low cost. (e.g. ETFENGSAA = 40% big oil, 30% drilling/support companies, 20% non-big oil refineries, 5% solar, 5% wind). Humans will always be needed, but not at the level as today. Finance, will, and should, go the way of the rest of industry in reducing human overhead.

    It’s disruptive, but our current finance segment is exactly the opposite of what the data shows. Financial “professionals” capture much of the real productivity gains and contribute almost nothing (compared with a well programmed computer).

    This was the basic MF argument about monetary policy. A computer can do a better job at keeping the money supply equal to the increase in real productivity than humans can. Still a good view I think.

  19. His argument boils down to the ownership of those ETF? Why should I care? Should everyone start trying to pick stocks instead? Or revert back to buying those badly managed, overpriced mutual funds?

    I think what’s bad is people trading those triple leverage or Futures based ETF without properly understanding them, then crying foul when they inevitably get burned. Anyone remember the trouble with TVIX? It says right in the prospectus if you hold it for a longer time you’ll lose all your fucking money. Well, it doesn’t say “fucking”, but it’s bolded and underlined and everything.

  20. I don’t think you can really get a company off the ground with an IPO these days. Do you think the average saver should even be in the business of investing in new ventures or IPOs? There’ll always be people trading in those niches.

    I think the implications will mean a more and more correlation in stocks that are in any of the major indices, and the companies that are in the index may start to reflect underlying fundamentals, making fundamental analysis even more useless.

  21. That was supposed to say that companies in the indexes may start to reflect underlying fundamentals less and less.

  22. I’m sure that there will be an IPO ETF one day, if one doesn’t exist already.