Courtesy of Knowledge@ Wharton

Tightening Belts

There are signs that Americans are taking their finances more seriously since the crisis hit. McNabb is encouraged that consumer debt has gone down and savings rates have gone up to around 6%. Although the rate has been higher in the past, the actual number of dollars Americans are saving (after adjusting for inflation) is as high as it has been for 30 years. "We view this as a very positive thing. Again, I did not understand a lot of the commentary last year or the year before encouraging consumers to spend, spend, spend and [that] savings was a bad thing. Of course, it was meant to spur the economy, but having a high long-term savings rate is an incredibly important element in a healthy economy."

The belt-tightening could work out well for Vanguard, which brought the first index fund to the small investor in 1976 and prides itself on low-cost investing. McNabb sees more investors turning to indexing -- or "passive" investing -- as they realize its value compared with actively managed funds that charge high fees. "We're in a lower-return environment, so people are paying more attention to cost," said McNabb. "Today, index assets represent about 15% of mutual fund assets overall. The preponderance of assets is still in actively managed funds. That's going to change over the next decade. We're going to see a continued move towards indexing. Indexing doesn't work because markets are efficient.... Indexing works because it's low-cost. And the cost differential between active and passive is so dramatic that it's tough for an active manager to out-perform an index fund on an after-cost basis.... People are starting to figure this out."

In the end, McNabb is very optimistic about America's future because of what he has seen in its past. "I think there's a lot of old-fashioned ingenuity" in the United States, he said. Throughout American history, he noted, tough economic times spurred innovations, inventions and the growth of new businesses -- from zippers to fiberglass, instant coffee and the creation of the assembly line. "[Vanguard] looked at when companies were formed and [found that] 80% of the S&P 500 [companies] were created either during a recession or within two years of coming out of a recession," McNabb said. "This is one of the reasons I remain incredibly optimistic, because we just went through a really deep recession."

And as the world economy grows, so do opportunities for the next wave of businesses and innovations, McNabb suggests. Emerging economies hold promise for American entrepreneurs who can find ways to work with new expanding markets. "I don't like the term 'emerging' anymore because China is the second-largest economy in the world," McNabb said. "At this point, it's hardly emerging. It's emerged. You're going to see faster growth in some of those areas rather than traditional places, and I think that's going to be a big trend for business start-ups.... The next innovations [in the U.S.] are going to serve some of those markets.... I think there are going to be a lot of opportunities like that for people who are nimble ... and who can figure out what that wave is going forward."