The formation of Vanguard largely went unnoticed by the press. Today, one searches in vain for any recognition in the financial media that a new company had been born, let alone a new company that had broken the traditional rules of mutual fund structure.

 

 

Then again, nobody in 1974 really could have predicted that an upstart firm, founded at the bottom of a vicious bear market, would overcome all odds and not merely survive, but ultimately dominate the mutual fund industry.

In 2017 alone, we estimate that Vanguard’s low costs saved investors $ 29 billion in fees and expenses. 2 If we carry this process back to Vanguard’s founding in 1974, the aggregate savings for Vanguard’s investors–average economies of scale plus our negotiation of appropriate fee structures with our advisers–can be fairly estimated at $ 217 billion. I take great pride in the fact that the company I founded has been able to give so much back to its shareholders/ investors. They deserve every penny of it.‘

 

‘Almost a century has now passed since 1924, when the first U.S. mutual fund was incorporated. Yet only during the past several decades have investors come to fully embrace the truth that Vanguard holds self-evident: Stock returns are ultimately created by corporations, and the financial system subtracts value from those returns. To reiterate, rather than wearing the royal clothes of market-beating professional management, the mutual fund emperor is wearing no clothes at all. In fact, it isn’t only the mutual fund emperor who is naked, it is virtually the entire mutual fund empire. The returns earned for fund shareholders have been dragged down by excessive costs, making the industry unable to deliver on its implicit promise. The concept that fund managers as a group could not add value to the wealth of their clients, once considered nearly heretical, is now broadly accepted. It has led to a disruptive revolution in the mutual fund industry, largely driven by the rise of index funds. The index revolution, in turn, has been led by Vanguard.

For the first time in world history, data exists for almost every aspect of global development. And yet, because of our dramatic instincts and the way the media must tap into them to grab our attention, we continue to have an overdramatic worldview. Of all our dramatic instincts, it seems to be the fear instinct that most strongly influences what information gets selected by news producers and presented to us consumers.

 

Critical thinking is always difficult, but it’s almost impossible when we are scared. There’s no room for facts when our minds are occupied by fear.

The media cannot resist tapping into our fear instinct. It is such an easy way to grab our attention. In fact, the biggest stories are often those that trigger more than one type of fear. Kidnappings and plane crashes, for example, each combine the fear of harm and the fear of captivity. Earthquake victims trapped under collapsed buildings are both hurt and trapped, and get more attention than regular earthquake victims. The drama is so much stronger when multiple fears are triggered. Yet here’s the paradox: the image of a dangerous world has never been broadcast more effectively than it is now, while the world has never been less violent and more safe. Fears that once helped keep our ancestors alive, today help keep journalists employed.

Money and capital markets are shared hallucinations whose value is more psychological than physical. The human mind gave rise to financial markets and to seek to understand them without an appropriate understanding of their genesis is folly in the extreme. There is no understanding markets without understanding people.

 

Our brains have remained relatively stagnant over the last 150,000 years, but the complexity of the world in which they operate has exponentiated. Formal markets like our stock market are just about 400 years old. It would be a gross understatement to say that our mental hardware has not caught up to the times.

The world is full of well-educated people who have made stupid choices, a phenomenon referred to by scientists as “dysrationalia.” A survey of Canadian Mensa Club members, whose membership is limited to those in the top two percentiles of IQ, demonstrates this nicely. Among those surveyed, 44% believed in astrology, 51% bought into biorhythms and 56% believed that Earth has been visited by aliens.

 

 

“Even once we are aware of our biases, we must recognize that knowledge does not equal behavior. The solution lies in designing and adopting an investment process that is at least partially robust to behavioral decision-making errors.”

Time magnifies the margin between success and failure. It will multiply whatever you feed it. Good habits make time your ally. Bad habits make time your enemy. Habits are a double-edged sword. Bad habits can cut you down just as easily as good habits can build you up, which is why understanding the details is crucial. You need to know how habits work and how to design them to your liking, so you can avoid the dangerous half of the blade.

Goal setting suffers from a serious case of survivorship bias. We concentrate on the people who end up winning—the survivors—and mistakenly assume that ambitious goals led to their success while overlooking all of the people who had the same objective but didn’t succeed.  Every Olympian wants to win a gold medal. Every candidate wants to get the job. And if successful and unsuccessful people share the same goals, then the goal cannot be what differentiates the winners from the losers. It wasn’t the goal of winning the Tour de France that propelled the British cyclists to the top of the sport. Presumably, they had wanted to win the race every year before—just like every other professional team. The goal had always been there. It was only when they implemented a system of continuous small improvements that they achieved a different outcome.

The decisions we make in our lives—in business, saving and spending, health and lifestyle choices, raising our children, and relationships—easily fit von Neumann’s definition of “real games.” They involve uncertainty, risk, and occasional deception, prominent elements in poker. Trouble follows when we treat life decisions as if they were chess decisions.

 

In chess, outcomes correlate more tightly with decision quality. In poker, it is much easier to get lucky and win, or get unlucky and lose. If life were like chess, nearly every time you ran a red light you would get in an accident (or at least receive a ticket). If life were like chess, the Seahawks would win the Super Bowl every time Pete Carroll called that pass play.

But life is more like poker. You could make the smartest, most careful decision in firing a company president and still have it blow up in your face. You could run a red light and get through the intersection safely—or follow all the traffic rules and signals and end up in an accident. You could teach someone the rules of poker in five minutes, put them at a table with a world champion player, deal a hand (or several), and the novice could beat the champion. That could never happen in chess.