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Vanguard founder Jack Bogle's market warning sign

Lee Brodie
Vanguard founder Jack Bogle's market warning sign

With the Dow Jones industrial average (Dow Jones Global Indexes: .DJI) and S&P 500 (CME:Index and Options Market: .INX) trading near all-time highs, is the market too hot?

On CNBC's " Closing Bell ," legendary investor Jack Bogle, the founder of The Vanguard Group, revealed his strategy for determining when stocks are overbought, broadly.

As a pioneer in the industry and advocate of index funds including the Vanguard 500 Index Fund (NASDAQ:VFINX-O), which tracks the S&P 500, Bogle is keenly aware of valuations in broad market.

"Using the S&P 500, 20 times estimated future operating earnings," Bogle said. "That's a good warning sign."

In other words, when the market trades up to that earnings multiple, then Bogle believes the market is becoming overbought. At that level, he said "the market is on the high side."

However, until that time, he would remain bullish.

"It's all in the math," he said.

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Also, Bogle believes that broadly, investors who put money to work in an index fund will outperform their actively managed peers; mutual funds.

Although fund managers can, theoretically, move in and out of stocks and protect clients, mutual funds charge fees. "And funds, on average, stay 95 percent invested in stocks," he said.

Therefore, Bogle says the costs and fees of mutual funds outweigh all other considerations, and ultimately prevent investors from maximizing returns.

By contrast, "Our Vanguard 500 Index fund delivers the market return less 5 basis points. That's 0.05 percent. So mutual funds that are charging one percent or two percent; they just can't compete."

"We started this structure 40 years ago," Bogle added. "And it's sensational because of its cost savings. It's an adherent advantage."