2013 Preview: Happy Last Year!

It's the end of the year as we know it, and I feel fine.

Rightly so with the DOW closing at 13,105.37, which was up about 7.25% (a bit off what I had predicted) after a highly volatile year, which saw the closer-than-expected re-election of President Obama and ended among fiscal cliff scares.  Even though the markets closed up, I admittedly expected a much higher gain than we actually enjoyed  (more along the lines of the S&P 500, which closed up 13%).  Lots of factors came into play that I had not anticipated, but in the end, the markets are just as unpredictable as always.  Most logic behind the market moves is superimposed in hindsight.  It would be like a "lottery analyst" providing reasoning behind the randomly generated winning numbers.

That said, predicting the market movements for the upcoming year is simply fun, and I'm not going to miss out on any fun this week!

I was heavily weighing the likelihood that the markets will decline in 2013.  When the market tanked in 2008 before bottoming out in February 2009 at 6,500, I said that it would fully recover in 7 years (snapping previous "fastest recovery"-time in half).  That was only four years ago, so if the markets went up another 10% in 2013, then it would reach a new high above 14,500.  It sounds unlikely, and unbelievable, and next to impossible.  It sounds like the words of a dreamer.

Then, there's reality.  The all-time high for the market was set over five years ago now.  In that short span, the markets went from 14,164 on October 9, 2007, to 6500 in February 2009 and back to 13,610 on October 5, 2012.  Why?  There's a different answer for each different investor, but when it gets right down to the facts, pulling money out of the stock market is a statement that there are better earning opportunities for money elsewhere.  Where?  When money comes out of stocks, then it will most likely go to bonds or money markets.  The return on money markets right now rounds down to $0 and the near-future of bonds is even more sketchy than that of stocks.  Where can that current money in the stock market (and new money coming in) go?  There are not many better options outside of stocks, so behind that reasoning, I expect the markets will post a positive return of less than 10% in 2013.

This situation almost begs the question when will money markets and other stable value options start offering significant returns again.  It stands to reason when the stock markets reach new highs will be the most likely time, but then again, the stock market retracted so quickly and recovered faster than expected, so its volatility has never been higher.  Simply offering a secured investment option may be luring enough for investors looking to avoid stocks for as long as the markets are this volatile.   If that observation has enough truth to it, then the answer is that money markets will not offer significant percent returns until the market is less volatile, and as great as it was for stockholders when the markets double in three years, there's no question that the huge spike was as volatile as the sharp fall.  Many analysts (perhaps the majority at this point) will admit that the markets are extremely volatile with few signs of gaining stability.

That said, the money markets may no longer need to offer a return on investment so long as they are guaranteeing a safe return of your investment.  At this point, it stands to reason, but the thought of it is still quite mind-blowing.  For all we've gained with the changes since the Internet ushered in the Information Age, there is plenty we have lost unexpectedly (sometimes, noticeably).  Getting 3-5% on a money market may be one of the casualties that few people notice.

Buy The Next McDonald's (MSN Money)

Buy the next McDonald's
The burger giant has delivered for investors for years, but there are signs its growth is stalling. Here are 5 competitors that could grow faster -- and the 2 best bets among them.
by Charley Blaine, MSN Money|11/27/2012 5:15 PM ET


McDonald's. The name means burgers and fries, Chicken McNuggets and Egg McMuffins -- to almost everyone in the world.

McDonald's (MCD -0.15%, news) also means a stock that jumped 148% in value between the end of 1999 and 2011, delivering for investors even in the worst of times. It was one of just two stocks in the Dow Jones Industrial Average ($INDU -0.56%) that finished the horrible year of 2008 with a gain.

But the company has hit a wall in 2012. Consumers are wary in a difficult economy. And McDonald's is so big that it's hard to find enough growth to move the needle. That makes it time for investors to look for companies with similar positives and lots more room to grow -- giving them the potential to outperform the Golden Arches over the next few years.

I've found five with that potential: Jack in the Box (JACK +0.54%, news), Sonic (SONC -0.95%, news), Yum Brands (YUM +0.24%, news), Chipotle Mexican Grill (CMG +0.78%, news) and Red Robin Gourmet Burgers (RRGB +1.20%, news). First we'll look at why McDonald's works -- then ask which of these five is most likely to grow into this "next McDonald's."

Why McDonald's is unique
First, we have to acknowledge McDonald's amazing position. The company has a market value of $84.4 billion, the most of any fast-food company and larger than its three largest competitors -- Starbucks (SBUX -0.78%, news), Yum Brands and Chipotle Mexican Grill -- combined.

Some 69 million people a day buy a meal at any of 34,000 McDonald's restaurants in 119 countries -- nearly 48,000 sales a minute. In 2011, company-owned and franchised restaurants generated nearly $86 billion in food sales.

The company has boosted net income nearly 14% a year for the past five years. Dividends have grown 20% a year for five years. If you're happy with a reliable stock paying a 3.6% dividend yield, it's still a solid stock to own.

Sure, performance has been stagnant of late, with Europe a particular problem. The stock is down 14% this year, third-worst among the 30 Dow stocks. Same-store sales fell 1.8% in October, the first monthly decline in nine years. But McDonald's has worked through downturns before. In 2003, for example, shares dipped to the $14 range. They were a steal at that price: They now go for $86.

If you'd bought 100 shares of McDonald's when it went public in 1965 at $22.50 a share and didn't sell through 12 splits, your stake would have grown to 74,358 shares worth about $6.41 million. That's a gain of roughly 285,000%, or 18.4% a year. The total return is larger if you include dividends.

There are three keys to McDonald's success:

Foolproof formula for franchisees. McDonald's has achieved its bulk -- OK, prominence -- by providing its franchisees a nearly foolproof formula for success. Sites are carefully chosen and usually owned by the company, which gets a cut of rents as well as sales.

Menus and preparation processes are standardized. A vast network of suppliers sells the raw ingredients following strict standards.

The assembly-line system of food preparation -- first developed by founders Richard and Maurice McDonald in the 1940s and expanded by Ray Kroc, who started as a franchisee and later bought out the brothers -- ensures a Big Mac in Tours, France, is the same as one in Montgomery, Ala.,

Evolving with the times. Success brings envy, controversy -- and evolution.

In the 1990s, its franchisees, who own 81% of the restaurants, complained that the company was selling too many franchises. McDonald's has been hit with repeated charges that mass consumption of Big Macs, french fries and related fare from other chains was responsible for growing obesity rates. And to social critics abroad, its omnipresent, standardized fare has represented the worst in American culture.

But Mickey D's has adapted. Existing franchises are being modernized with renovated or rebuilt stores, some 900 in 2011 and 1,000 expected this year. To answer dietary critics, it has broadened its menus to offer wraps, salads and fruit; it now sells more chicken sandwiches than burgers. Because McDonald's saw Starbucks' rapid growth as a threat, it now offers the McCafé line of gourmet coffees. And it bends its menus overseas to local tastes.

Financial strength. McDonald's backs up its franchisees with the cash to make improvements to stores and, as important, amazing marketing. It is one of the 15 largest advertisers in the world, with a $2.3 billion advertising budget that dwarfs those of Subway, Burger King (BKW +1.54%, news) and Wendy's (WEN +0.21%, news).

5 competitors, 5 strategies
The "next McDonald's" we're looking for won't look exactly like the one we have. Many of its rivals offer a different slant on fast food -- just as McDonald's reinvented fast food and franchising. One trend that's been growing in recent years is fast casual. You enter and order your food, which is prepared while you wait.

The financial game plans are different. Yum has a small dividend; Sonic, Jack in the Box, Chipotle and Red Robin don't offer dividends as yet.

Here's a look at our five contenders:

Yum Brands (YUM +0.24%, news). While McDonald's shares are down this year, Yum's shares are up about 22%. The company owns the KFC, Taco Bell and Pizza Hut chains and is making a huge and, so far, successful effort to be a major player in China. It has 38,000 restaurants already, mostly franchised, and is betting that its mix of chicken, Mexican food and pizza will succeed in Asia. There's ample room for growth, and while each brand has had problems over the years, all have improved in terms of image and quality.

Still, those brands aren't exactly new and different, so they could be a tough sell if consumers say "been there, done that." If China's economy truly falls apart, so will Yum shares.

Jack in the Box (JACK +0.54%, news). A storied name, Jack remains a small, mostly West Coast chain. The stock has been a pretty good performer, up 20% to $25.10 this year, but it has fallen 12.5% since mid-September when the overall market peaked. It has two lines of business -- Jack in the Box and the Qdoba chain, which offers fast-casual Mexican food.

Like Yum, it faces a potentially nagging problem in that its brand is already well-known. But the smaller footprint eases that worry.

Plus, the company has a lot of real estate, and, wrote Charles Sizemore of the Sizemore Investment Letter recently, Qdoba has the potential to grow quickly, capitalizing on consumer demands for fresher foods.

Sonic (SONC -0.95%, news). A classic drive-in burger chain, complete with carhops, the Oklahoma City company is smallish: only 3,500 stores, 88% franchise-owned. Revenue is less than $600 million a year. The stock, however, has been a winner so far this year, up nearly 38%. It's been digging itself out of a hole caused by the recession and a reputation as the poor man's McDonald's. It has growth prospects in the Northeast and northern Midwest and on the West Coast.

A warning, though: Volatility goes with these shares. They fell 74% between November 2007 and November 2008. They've ranged from $6.50 to $12 or so ever since. Analyst Paul Westra of Cowen & Co. thinks the chain is more vulnerable to the economy than others. Size is an issue. It also has a heavy 8-to-1 debt-to-equity ratio.

Chipotle Mexican Grill (CMG +0.78%, news). This fast-casual chain offers burritos and tacos. It grew from 16 restaurants when McDonald's bought into the company in 1998 to more than 500 when McDonald's sold its position in 2006. It has 1,200 locations in the United States, Canada and the United Kingdom. It is just starting to roll out a new concept: ShopHouse Southeast Asian Kitchen, featuring serving bowls and banh mi sandwiches

Here are the rubs:

• The company's comparable-store sales were up only 4.8% in the third quarter, compared with 8.3% for the first nine months and 11.3% a year ago.
• The company expects less robust growth for the fourth quarter and flat-to-low single-digit growth in 2013.

The stock jumped 1,020% between November 2008 and early April -- but has fallen 41% to as low as $233 before rebounding back to $275. It has lots of cash to finance new growth: nearly $410 million at the end of the third quarter. It has no debt. If you're interested, watch the stock's chart carefully for a bottom -- you want to go in at a relatively low price.

There are plenty of growth opportunities in Europe and Canada for Chipotle stores. It may get an additional boost if the Asian kitchen business works.

Red Robin Gourmet Burgers (RRGB +1.20%, news). Founded in Seattle, the Denver-based company has 463 full-service restaurants (331 are company-owned) concentrating on burgers and a few other entrees, plenty of fries and a full-service bar. On a Friday night, you'll find families celebrating birthdays on one side of the restaurant and couples enjoying a modestly priced night out on other.

The company saw revenue slip 3.2% in fiscal 2008 as the financial crisis hit and profit slid. Business rebounded in 2010 and 2011 and looks poised to finish 2012 with revenue approaching $950 million. The stock is up nearly 13% this year and up 250% from its bottom in November 2008.

Red Robin has lots of room to grow. Most of its restaurants are in the Western United States, British Columbia and Alberta. The company is carefully expanding into the Southeast and into the Northeast.

It is also experimenting with a fast-casual service concept. A number of analysts are watching to see how its Red Robin Burger Works concept fares. These basically offer burgers, fries and desserts that are cooked on the spot, much like Qdoba or Chipotle. They require less space to operate and are able to serve customers quickly. Red Robin has opened five -- four in the Denver area and a fifth near Ohio State University in Columbus. Four more are expected to open in the fiscal fourth quarter.

Take Jack in the Box and Red Robin
McDonald's has three advantages over all these companies: Size, brand and a 3.6% dividend. The cautious investor will still find these shares attractive. The company, however, does face increasingly intense competition from just about everyone from Burger King and Wendy's to Chipotle, Panera Bread (PNRA +0.06%, news) and Starbucks, Lazard Capital analyst Matthew DiFrisco wrote Monday as he cut his rating on the stock to "neutral" from "buy."

So if you're looking for equally solid returns and better growth in the next few years, the best bets look like Jack in the Box and, especially, Red Robin. The other three have bigger question marks to go with their possibilities.

Jack in the Box is in the midst of what appears to be a successful turnaround, with a new brand -- Qdoba -- providing additional growth. Red Robin looks to have a solid strategy that appears to weather economic stress well, and its Burger Works looks to be an innovation with potential.

Burrito Battle: Taco Bell vs. Chipotle (MSN Money)

Burrito battle: Taco Bell vs. Chipotle
The success of upscale offerings from a celebrity chef has Taco Bell eating into the upstart's business. That's showing up in stock prices as once-hot Chipotle faces tough times.
by Michael Brush, MSN Money|12/4/2012 6:45 PM ET

To most people, burritos are just a tasty lunch treat.

But to a couple of lunchtime giants, burritos are the weapon of choice in a fierce fast-food battle.

The battle broke out last summer when Taco Bell, a division of Yum Brands (YUM +0.28%, news), rolled out its new Cantina Bell menu.

Developed by celebrity chef Lorena Garcia, of Bravo's Top Chef Masters fame, the Cantina menu features a premium burrito with black beans, cilantro rice and marinated chicken or beef for under $5, plus new sides like corn salsa. (Search for details on Cantina Bell menus on Bing.)

Based on recent company numbers, Taco Bell clearly scored a win with these upscale offerings. And it's no wonder. They are an unabashed imitation of the extremely popular offerings of Chipotle Mexican Grill (CMG +0.65%, news), known for upscale burritos packed with fresh ingredients and hormone-free meat.

Yum Brands executives have no problem admitting they borrowed a key insight from Chipotle -- that customers will pay more for better quality, fast-casual Mexican food. "That's what Taco Bell can deliver, and at two-thirds the price of our fast-casual competitors," CEO David Novak said on a recent earnings call.

Now, this victory is probably not the only reason Yum's stock is up 5% since July 1, despite a drop last week, while Chipotle shares -- once hotter than jalapeños -- have fallen some 30%. But in the fiercely competitive world of fast food, consumer buzz is critical. And Taco Bell has it right now.

Chipotle's problem: A 'resurgent' Taco Bell
Many analysts -- and Chipotle itself -- maintain Taco Bell's new burritos are no threat to Chipotle, because their customers are so different. The customers who buy Chipotle's burritos, at $7 or so each, typically make more money. They appreciate Chipotle's ambience and careful sourcing of fresh ingredients, as a lifestyle choice.

Theoretically, at least, this is supposed to prevent them from crossing over to Taco Bell, with its more downscale, run-for-the-border, midnight-munchie reputation. There's also a been there, done that issue with Taco Bell, which can trace its history to 1946 (it went public in 1970); Chipotle got started in 1993 and is still fresh to many people, as it's still rolling out lots stores each year to new regions."We don't see Taco Bell as being a threat at all," Chipotle spokesman Chris Arnold told The Wall Street Journal in early October. "There's a lot more to what we do than grilled chicken and corn salsa, and we believe customers see the difference."

But legendary hedge fund manager David Einhorn disagrees. Einhorn, of course, is well known for highly successful negative bets against Green Mountain Coffee Roasters (GMCR -0.99%, news) and Lehman Brothers before each tanked. At a New York City investor conference on Oct. 2, the Greenlight Capital hedge fund manager laid out his case against Chipotle, which he's had negative bets against this year.

The bottom line: A "resurgent" Taco Bell endangers once-hot Chipotle.

Einhorn says a survey his hedge fund conducted found that Chipotle and Taco Bell customers actually don't see much difference between the two chains. And his survey found that 75% of Chipotle customers go to Taco Bell. "Taco Bell has started to eat Chipotle's lunch," he said at the conference. "Less long exposure to Chipotle stock is a good idea."

Though fast-food experts -- and Chipotle -- dismissed Einhorn at the time, his case suddenly seemed to make a lot more sense on Oct. 19, when Chipotle announced a slowdown in sales that tanked its stock.

On the earnings call, Chipotle managers denied the slowdown had anything to do with Taco Bell.

"There was a lot of noise during the quarter about somebody taking market share away from us," said co-CEO Montgomery Moran. "We're not seeing any kind of loss whatsoever in our transactions moving from us to any other competitor."

But I think Chipotle and the analysts may be wrong, and that Einhorn is on to something. Here's why.

Driving diners loco
First, Chipotle's explanation that a weak economy caused its sales slowdown doesn't ring true, since the economy was weak a year ago when Chipotle growth was going gangbusters.

But more important, consider some interesting results from a survey of fast-food diners conducted by Goldman Sachs in late September -- almost three months after Taco Bell's new Cantina Bell burritos were launched.

The survey found that Chipotle's "brand equity" score among consumers fell sharply to 65.8 from 70.4. Meanwhile, Taco Bell's score rose to 64.8 from 62.1.

Two other insights stand out. One is that Chipotle's score fell "meaningfully" across all demographics. This seems to confirm Einhorn's findings that well-heeled customers who are supposedly loyal to Chipotle may have no problem defecting.

Second, Taco Bell is clearly on a roll in coming out with innovative dishes that customers love. Its brand-equity score was a lowly 58 a year ago. (All fast-food joints score in a range of 53 to 71.)

Taco Bell came out with a big hit in March -- it's Doritos Locos Tacos, which have shells made of Nacho Cheese Doritos. The chain sold an astonishing 100 million of these tacos in the first 10 weeks. And now the new Cantina Bell menu is obviously a hit. Taco Bell sales at stores open more than a year grew by 7% in the third quarter. In contrast, Chipotle's growth was 4.8%.

None of this proves Chipotle customers have turned to Taco Bell. But the ratings changes in the Goldman Sachs survey coincide with a sharp decline in growth at Chipotle and an increase in growth at Taco Bell, suggesting that something like this is going on.

Plus Goldman Sachs says Taco Bell's growth was driven by an increase in traffic, and not just increased spending and visits by regulars. "Taco Bell is now attracting more new customers than either Chipotle or Qdoba, its primary Mexican peers," concluded Goldman Sachs analyst Michael Kelter. The number of people saying they've eaten at Taco Bell rose sharply this year, while it declined at Chipotle, the survey found.

Taco Bell's 2012 success is part of a larger trend. Over the past five years, Taco Bell customer satisfaction has jumped sharply, according to American Customer Satisfaction Index surveys. "Their improvement over the last five years is the biggest in the industry," says ACSI director David VanAmburg. "It's pretty impressive."

Chipotle's burrito bummer
None of this is good news for Chipotle, which faces a rough outlook for two reasons:

* The Goldman Sachs survey found that restaurants are at the top of the list of things consumers are cutting out, and that when they do eat out, price is the one of the main factors in deciding where to go. This plays into the Taco Bell strategy of offering Chipotle-quality Mexican food, but at a lower price
* Emboldened by its success, Taco Bell is not done taking shots at Chipotle with upscale Mexican. Chef Garcia is developing new burritos, a roasted tomato and garlic salsa and new steak offerings, as well as continued work as spokeswoman for the chain.

Yummy sales
Garcia's success so far has been much-needed good news for Yum Brands. True, Taco Bells make up only about a third of the U.S. fast food joints run by Yum, which also operates Pizza Hut and KFC. And U.S. sales account for only 26% of operating earnings at Yum Brands, which has a big presence around the world, especially in China.

But Taco Bell's success matters because it moves the needle.

Indeed, given the surprising China slowdown that Yum just announced, the Taco Bell burrito wars are now more important than ever for the company. On Nov. 29, Yum surprised investors by saying China sales will contract 4% in the fourth quarter, compared with 21% growth a year ago. The stock fell from above $74 a share to below $68. Yum now expects to report 6% same-store sales growth in China for this year. Thus Taco Bell's 7% growth in the third quarter was not only better than growth at Pizza Hut (6%) and KFC (4%), but it's also doing better than China, once considered the sweet spot for the company.

The key investing takeaways
Once the dust settles in the current burrito battle, it will be clear that both companies still have solid potential.

Chipotle remains a great fast-food concept, with plenty of room to open new stores. It plans to open 165 to 180 restaurants next year, on a base of about 1,300.

"If you have a concept that has proven out and you can just keep opening stores with a rate of return that is reliable, that is a very compelling growth story," says Sarah Henry, an analyst for Manulife Asset Management. Chipotle has also hinted it may take a shot back at Taco Bell by introducing drive-through stores, long a favored Taco Bell format. Plus Chipotle is expanding its approach, with its ShopHouse Southeast Asian Kitchen fast-food restaurants. In short, Chipotle stock may well lose more ground as the ongoing burrito wars play out. So you'll probably be able to buy it lower. But Chipotle is not out of the game.

At Yum, the sharp downturn in China is more of a mystery. But my guess is that as China's economic growth shores up, Yum will be OK. It too has plenty of room to grow by opening new stores in China.

"We very much like the China story," says Di Zhou, an equity research analyst for the Thornburg Value Fund (TVAFX -0.41%, news). One reason is that China has a population of 1.34 billion. "That is many mouths to feed." She says Yum has done a good job of adding local fare, such as soy milk, Chinese porridge and doughnuts, to its standard KFC chicken offerings.

Zhou also believes Yum will continue to benefit from China's growing middle class and ongoing urbanization. Morgan Stanley estimates that consumer spending in China will triple within a decade, which has got to be good news for Yum.

As investors wait for China growth to kick in again, Taco Bell's success in the U.S. burrito battle will continue to help support earnings, and Yum stock.

Fast-food stocks at slow-food prices
Neither of these stocks, however, will be hits with value investors looking for relatively low prices, even considering the recent stock declines.

Chipotle trades for 25 times its forward 12-month earnings. This gives it a price/earnings-to-growth ratio of 1.4. Developed by investing icon Peter Lynch, the PEG ratio adjusts a company's valuation for its growth rate. Generally, a PEG ratio above 1.5 makes a growth company look pretty fairly valued.

Yum Brands trades for 18.1 times forward earnings, and an even richer PEG ratio of 1.58.

In contrast, McDonald's (MCD -0.15%, news) trades for 10 times forward earnings and a PEG ratio of about 1.

These fairly rich valuations don't mean these stocks can't do well. They should, because of the bullish expansion potential. But Chipotle still may go lower because of the ongoing burrito battle, while Yum gets back on track and moves higher.

At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column. 

Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.

CNNFN: Jack Bogle, Vanguard's $2.2 Trillion Man

Jack Bogle: Vanguard's $2.2 trillion man
There are many steps to managing your money wisely. A good way to start: a visit with the father of indexing, Vanguard's Jack Bogle.
By Andy Serwer, managing editor

FORTUNE -- What if your life's work could be measured by one simple number, and what if that number was 2.2 trillion? As in dollars. I walked into an upscale Midtown Manhattan restaurant looking for such a man. He was easy to spot. Not because he was oozing wealth from every pore and surrounded by an entourage -- but because he wasn't. Over there in the corner, he's the older fellow in a plain suit and a boring tie who looks a tad uncomfortable in a place that serves up Spanish Octopus a la Plancha, with sofrito, cocoa beans, marble potatoes, and serrano ham. (He would have a hamburger -- hold the pickled ramp dressing.)

John C. "Jack" Bogle, 83, didn't build Vanguard into one of the biggest companies in the world by sitting around eating fancy Spanish octopus. He's all about keeping things simple. And he's a fighter, a cantankerous iconoclast, and more than a bit of a zealot. He officially retired in '99 and hasn't been in the best of health for a while, but he still believes adamantly that conservative, low-cost index funds are the best way -- nay, the only way -- to invest. And now so, too, do millions of Vanguard customers around the world. They've invested $2.2 trillion in the house that Jack built from scratch 37 years ago.

This is the third time I've written about Vanguard in my career at Fortune. The first was in 1991, when the company had around $80 billion under management; then again in 2001, when it had $540 billion; and now, after it has quadrupled in size over the past 11 years. (I know, I'm a year behind schedule.) In that time Vanguard has quietly become one of the greatest business success stories of our time. And over the decades I've come to realize a thing or two about the company -- namely, that it is truly unique and seemingly inexorable. Vanguard has grown in every kind of market as enlightened investors beat a path to its door.

In case you don't know, here's how Vanguard works: The company sells low-cost mutual funds (primarily index funds) and ETFs directly to investors, thereby bypassing brokers and their markups and marketing fees. The most important distinction, though, is that Vanguard is able to operate with the lowest margins in the business because, like a mutual insurance company, it is owned by its customers. (In Vanguard's case: investors in its funds.) Of course Vanguard pays its managers and executives. But instead of paying out profits to an owner or shareholders, the company's gains are instead realized by lowering costs. Got it? Meaning Bogle has built Vanguard into a global behemoth and yet not become fabulously wealthy. Which is a big reason no one else has seen fit to create another Vanguard. To do so, you'd have to be a true believer. And not many people are.

Bogle has met me to talk about his new book, The Clash of the Cultures: Investment vs. Speculation, in which he eviscerates most investing practices and much of what happens on Wall Street. "I don't pay attention to what others say. I say what I think," he tells me, while warily eyeing my Fall Roasted Root Vegetable Salad with petite lettuce, goat cheese, duck confit, figs, apple, and carrot vinaigrette. "I don't know how to do otherwise." (I think he wants to say something about my salad, but Jack does have some limits.)

The fundamental principles that Jack has always emphasized, and still does -- getting diversified market exposure, not giving your profits away in fees -- are the building blocks of success for the average investor. There is a lot of sophisticated advice in this year's Investor's Guide. And all of it -- stock picks from elite managers, market insight from seasoned pros, tips on buying real estate in your IRA -- can help give you a boost. But that doesn't mean we should ever lose sight of the basic, commonsense approach that works for Vanguard.

As I help Jack hail a cab to take him to Penn Station (no Town Cars or limos for him) to catch his train back to Philadelphia, I realize that when you boil it down, his success is a result of the power of independent thinking. Jack has consistently gone his own way and made up his own mind. It's an important point to remember when considering how to invest. Very few of us have the same ability as Jack. We need help and advice. But you should always ask yourself, What do I really think about, say, Apple's stock (AAPL) or a particular bond fund? Does investing my money there make sense to me? You may not build quite what Jack has, but thinking a bit more like him is sure to help you succeed.

This story is from the December 24, 2012 issue of Fortune.

CNNFN: Bond Investors, Beware!

Bond Investors, Beware
By Kim Clark @Money December 3, 2012: 6:03 AM ET
(Money Magazine) -- As Chief Investment Officer of Vanguard, George U. "Gus" Sauter, 58, is responsible for a staggering amount of fund investors' money -- some $1.9 trillion.

More important, he's saved a lot of investors' money. Almost 60% of Vanguard's assets are in passively managed index funds, so Sauter's biggest job has been to pare costs so shareholders keep more of their return. (It may not be glamorous, but it has paid off in performance.)

Along the way, Sauter guided the company into a booming market for exchange-traded funds, the portfolios that can be traded like stocks.

His perch as top investor at the country's largest fund manager has also given him a sharp view of the big picture. And part of that picture today is that bond investors -- who added $27 billion to Vanguard funds alone so far this year -- may be in for a bumpy ride.

Sauter retires from Vanguard at the end of the year. He spoke with MONEY senior writer Kim Clark; their conversation has been edited.

In the past five years, we've had a crisis on Wall Street, wild volatility, and outflows from equity funds. Are investors losing faith?

We're worried about that. But we do not think the markets are broken. I can't recall too many periods in my 25 years here where we didn't experience volatility. The market was down 21% on Oct. 19, 1987. And then the Asian contagion in the fall of '97, the Russian debt crisis, the tech bubble bursting.

Now we've got European debt, and we've got the fiscal cliff. Still, that does not convince us at all that you won't get normal returns going forward.

Why? Seems like there's a lot of economic danger ahead.

It turns out equity returns are not related to economic growth. The best predictor of future returns over the long term -- over, let's say, a five-or 10-year horizon -- tends to be current valuations. The market is priced at about 13 times [expected] earnings, and that is a little bit cheaper than normal.

What about bonds?

The best predictor of bond returns is the yield to maturity of the 10-year bond. The 10-year Treasury is at less than 2%, so returns would probably be 2%, maybe 3%. Historically bonds have returned about 6%. It's difficult to see how we could get that.

You've seen big inflows into your bond funds. Are you concerned investors are overdoing it?

Yeah. We're trying to educate clients to be aware of the risks. A rise in rates will negatively impact their principal. At the same time, we do believe that even with lower expected returns, bonds play an important part in the portfolio: diversification. You want to have that anchor.

Vanguard founder Jack Bogle has criticized overuse of exchange-traded funds. You've created dozens of them.

We think that ETFs are just a different way to distribute an index fund. You can invest in our Total Stock Market Index fund (VTI) either through the conventional share class or you can invest in the ETF.

It comes down to investor choice. Jack is concerned that people become market timers with ETFs. We have some research that is contrary to his view. Our ETF investors [in broad-based funds] do not have substantially different time horizons than our conventional shareholders.

I think Bogle's concern is about all the ETFs that focus on just a narrow slice of the market. Aren't those likely to be used by market timers?

I certainly share the concern with the proliferation of ETFs in the marketplace. We have data that show that with narrowly defined investments, investors are not invested in them on the way up. They pile in at the top and then ride them on the way down.

But you created funds for sectors like energy and health care.

We have funds for broad sectors, but we don't have industry funds or single-country funds. There's a level where you have to call it quits.

I was telling somebody I was going to interview the guy in charge of the big index funds, and he asked, "How can that be a full-time job?"

You want to see the number of people we have? [Laughs.] Indexes change more often than you might imagine. There's a lot of trading involved. On a given day, we'll do 5,000, maybe 10,000 trades.
Your last hurrah has been to change the indexes tracked by many Vanguard funds, including Total Stock Market. What exactly did you do and why?

We changed index providers. Index licensing fees have been a very rapidly growing component of costs, and we found a way to reduce that by switching. It will save hundreds of millions of dollars [for our clients] over time.

How does it change the funds?

For example, the index provider we will use for international funds classifies South Korea as a developed market, whereas the current index considers it an emerging market. Every person I know who knows anything about South Korea says it's a developed country. As a result, our developed markets index funds will now include South Korean stocks.

Are there any changes with the funds that follow U.S. stocks?

The Center for Research in Security Prices, which created the new U.S. indexes, have a process they call "packeting." Say a stock is transitioning from being a small- cap stock to midcap. Normally, Vanguard Small Cap Index would have to sell the stock, and then Mid-Cap Index would have to buy it.

With packeting, only half of the weight moves into that new classification. In the next quarter, if the stock remains above that band, only then does the remainder move. When you're at the border, you don't want to flip-flop back and forth. This cuts turnover by about 25%, and that means lower transaction costs.

Last question: Why retire so young?

As they say, it's the miles, not the years. And I wanted to have time to do other things.