(MONEY Magazine) – At first glance, nothing much seems to have changed at the Vanguard Group of Investment Companies. Oh, sure, $10 billion in new money poured into Vanguard in January--among the biggest floods of cash any fund company has ever soaked up in a single month--but otherwise the $725 billion giant seems the same as it ever was.

Behind the scenes, however, plenty is changing. Vanguard is grappling with the challenges of amazingly rapid growth. How can the paragon of low-cost investing keep cutting expenses while still delivering superior service? How will Vanguard provide not just the investments that all of its clients have always wanted but the advice that growing numbers of its customers now need? Can Vanguard's quirky, quasi-religious culture--part Don Quixote, part preacher, part crusader--survive its increasingly intense focus on efficiency? It's clear that how Vanguard handles these challenges will have a huge impact on its 17 million investors and on the fund business as a whole.

To understand today's Vanguard, you have to understand yesterday's. The firm began in 1975 after John C. Bogle proposed that the 11 Wellington funds "mutualize." Jack Bogle knew that every dollar that went to the fund management company was a dollar that came out of the fund investors' pockets.

So he took the mundane (but profitable) chores of keeping the funds' books and records away from Wellington Management, the firm that selected the funds' investments. In short order, Bogle had set up a firm called Vanguard to handle the administrative chores--and made the funds' investors the owners of the firm. Next he took the funds "no-load," cutting out brokers and their commissions of up to 8.5%. Then he introduced the first retail index fund, enabling investors to capture nearly 100% of the market's return at rock-bottom cost. (Today Vanguard 500 Index, at $96.1 billion in assets, is the world's largest fund.)

Starting in 1981, Vanguard took the next step. Instead of always hiring outside firms to pick investments for its funds (and pick off fat profits while doing so), Vanguard began managing portfolios itself. Since the funds also owned Vanguard's investment management arm, no profits went to outsiders. Bogle had turned the fund world upside down. He removed the middlemen who get rich off the fund investors' money. Every decrease in fund expenses at Vanguard put more net return into its investors' pockets.

By creating the most mutual fund company ever, Bogle may have come as close to communism as a diehard capitalist has ever gotten. Just as Karl Marx wanted workers to own the means of production, Bogle turned fund investors into the owners of the fund manager. Bogle knew just how radical his idea was. In a theatrical flourish, he sited Vanguard's headquarters just a few miles from the encampments at Valley Forge, Pa., where George Washington had rallied the revolutionary army into fighting shape.

At Vanguard's helm, Bogle refused to offer risky bond funds or gimmicky sector funds, preached the gospel of diversification and buy-and-hold, and shunned the "We're No. 1" performance-based advertising that typified other fund companies.

With his constant moralizing about putting the investor first, Bogle earned the nickname "St. Jack" and set the course that Vanguard has mostly stuck to ever since. Under his successor, John J. Brennan, even at the zenith of Nasdaq's late-1990s boom, Vanguard declined to offer tech-stock funds or hype online trading at its discount brokerage. ("Stepping aside during the bubble," says Jack Brennan, "feels good in retrospect.")

The next Jack

If Bogle was Jack-in-the-pulpit, the charismatic preacher who fired up the troops with his sermons on doing the right thing, then Brennan is the Jack-of-all-trades, the detail junkie who will grill his technology team for hours on the intricacies of software and hardware, or pepper the customer service staff with questions about telephone operations.

Compact, intense, as wiry as a whippet--he runs five miles daily on his lunch hour for relaxation--Brennan has the compressed energy of a coiled spring. He speaks slowly, calmly, coolly, in a soft and powdery voice, but there is steel behind his steel-blue eyes. Persist in a line of questioning he doesn't like, and Brennan lowers the temperature in the room with four tight words: "I just answered that." Brennan's preferred term for Vanguard is "the organization," and it's impossible to imagine Bogle ever saying, as Brennan does, that one of his greatest aspirations is to get investors to think of Vanguard as their "primary wealth-creation provider."

Under Bogle, any Vanguard employee who used the word "product" to refer to an investment had to drop $1 into a jar for charity. The idea behind Bogle's ban was to discourage Vanguard from treating its investors' life savings like a consumer commodity. But at the new Vanguard, senior executives are no longer afraid to utter the word "product" aloud. Brennan himself uses it.

And that should surprise no one--least of all Bogle. When, in 1995, Bogle announced that he would retire and appoint Brennan as his successor, he said, "Jack Brennan is the best person I could possibly have found to assume my executive responsibilities. He is a man of extraordinary character, intelligence, diligence and judgment." What Bogle did not say is that, back in 1982, he had hired Brennan away from S.C. Johnson & Co., the maker of such broom-closet basics as Fantastik, Windex, Scrubbing Bubbles and Toilet Duck. After years of fulminating against competitors for "selling investments as if they were soap," Bogle put a consumer marketer in charge of his company.

In a way it seems an inevitable evolution. Vanguard was running $150 billion when Bogle announced his retirement, and he had always admitted that the details of managing a big company were not his strong suit. Today the company is almost five times bigger, and it's hard to see how Vanguard could continue to grow primarily by preaching, as it did under Bogle.

A new VUE

But Brennan has hardly turned Vanguard into a hype machine. Although the firm has recently launched a passel of more speculative index funds based on narrow market sectors, it has also closed several funds when too much money came in too fast. "We are absolutely prepared to shut any product at any time," says Brennan.

What Brennan is focused on is keeping Vanguard's costs down. In the late 1990s, after searching for better ways to cut costs, Brennan settled on Six Sigma, the efficiency system whose most famous proponent is Jack Welch, the former chief executive of General Electric. The goal of Six Sigma is to break every business process down into its basic components--and then precisely measure and continuously improve each step, reducing flaws, raising productivity and cutting costs. Brennan named his variant of Six Sigma "Vanguard Unmatched Excellence," or VUE.

Today, VUE is panoramic at Vanguard. At the firm's headquarters, staff cubicles and executive offices alike are strewn with books like Six Sigma for Managers, Six Sigma for the Office, Six Sigma for Everyone or Six Sigma for Dummies. At Vanguard, being a "black belt" doesn't mean you can hack a brick in half with your hand. It means you're an expert in DMAIC (pronounced "de-may-ick"), or define, measure, analyze, improve and control--the essence of Six Sigma. The best employees show plenty of "on-the-bus-ness," meaning that, by embracing VUE, they have gotten on the bus.

So many of Vanguard's cubicles, hallways and entryways display multicolored bar graphs showing various measures of efficiency that these printouts start to seem like wallpaper. On a February visit, for example, a VUE graph just inside the entrance to Vanguard's immense mail-fulfillment center showed that 642 pieces of mail were going out per employee per hour. In the telephone service center, electronic display boards continuously monitor the maximum time any caller has been waiting on hold, along with roughly a dozen other measures of quality.

Too much of a good thing?

A few years ago, the cult of St. Jack--the worship of Bogle as a living investment miracle worker--still pervaded Vanguard's halls. That cult has largely been replaced by a systematic drive for maximum efficiency. VUE is at the heart of Brennan's drive to push Vanguard toward a permanent crescendo of high productivity at rock-bottom cost.

It seems churlish, if not downright ridiculous, to worry that a fund company could ever get carried away with cutting costs--when so many others are raising them. Yet James Riepe, a Vanguard alumnus who is now vice chairman of rival T. Rowe Price, wonders whether programs like Six Sigma are ideally suited to the fund business. "With no intermediary, the only personal impression an investor has [of a company like Vanguard or T. Rowe Price] is the quality of the contact with the customer service people," explains Riepe. "Six Sigma is a great way to reduce defects and get more perfect widgets off an assembly line in a shorter time. But that could be absolutely the wrong approach to customer service: There are times when you may want a longer phone call, not a shorter one. If the pressure for efficiency is too great, that could lead to perverse consequences."

For the first time ever, the Internet is aflame with complaints from Vanguard investors that echo Riepe's observations. As "john1963" posted on a bulletin board at morningstar.com in January, "By phone, I tried to get an answer to an obvious mistake by Vanguard, but was met by a very defensive responder. Instead of trying to help, they made excuses. I couldn't believe I was talking to Vanguard." Added Jeannette10: "After I thought the problem was resolved and the wrong account was deleted, it popped up AGAIN yesterday on my Vanguard site." And a former Vanguard employee, Doris (Dee Dee) Havens, has been circulating--to regulators, journalists and current Vanguard employees--an 11-page, single-spaced memo exhaustively listing alleged breakdowns in service.

Watch, don't worry

Some of this may be a natural outcome of Vanguard's enormous growth. Now that the firm has 17 million investors, even if Vanguard delivers perfect service to 99.9% of them, there would still be 17,000 disgruntled people. Still, managing director Michael Miller concedes that some investors have encountered service problems--especially in January, when, he says, "we got swamped" with that $10 billion in new cash from clients.

"I'm convinced that the [service] issues are transitory and volume-related," Brennan argues. "We are fanatics about monitoring client satisfaction." (Brennan calls Havens' memo "a litany of inaccurate and misleading assertions.") With the electronic display across from his office showing a maximum hold time of up to 10 minutes, Vanguard client relations boss Bill McNabb says the firm will hire "a couple hundred people" early this year to alleviate the service crunch.

Another element in the service equation is a bonus plan that Bogle set up in 1984: "the Partnership Plan," which awards employees bonuses for any year in which expenses drop and performance is good. According to former insiders, for low- and mid-level Vanguard workers, the payout can amount to 35% of salary; for senior executives, it can exceed 400%. (Daniel Wiener, editor of the newsletter The Independent Adviser for Vanguard Investors, estimates that in their best years Bogle earned about $3 million and Brennan about $5.5 million.) Thus the top brass can grow rich by cutting costs for Vanguard's fund owners.

Jack Bogle has heard about the service complaints at Vanguard. Does he think investors should worry that cost cutting is out of control or that the top brass are overpaid? "I wouldn't worry at all," says Bogle, "but I would watch. Or as Ronald Reagan said: 'Trust, but verify.' So keep watching. Don't overwatch the costs; watch the strategies, watch the compensation."

Where the rubber meets the road

The flash point for this issue--whether Vanguard can sustain the balance between low costs and high-quality service--is in providing financial advice. As Vanguard's clients age and grow wealthier, they need more than just investments. Instead, says Brennan, they are saying, "Help me be a better investor." And providing investment advice is much more costly than providing investments alone--since it must often be delivered one-on-one, typically by a trained financial planner, and can require time-consuming customized research. How will Brennan coax investors into thinking of Vanguard not just as an investment manager but as an advice giver? "It's less reaching out than having people reach in," he says. "You're not going to see Super Bowl ads from us, or have us sitting at your kitchen table."

What does that mean in practical terms? So far at least, Vanguard is dead set against opening walk-in offices around the country or creating a network of external financial advisers, as Schwab has done. Instead, Vanguard expects to deliver its advice almost exclusively online and by phone. And Vanguard will continue to charge separately for most financial advice--$500 for an investment plan prepared by an on-staff certified financial planner, and a maximum fee of 0.75% annually for assembling and monitoring a portfolio of Vanguard funds. By assessing separate fees, Vanguard wants to ensure that clients who do not need advice don't end up subsidizing those who do.

The real trick will be to find ways of individualizing and personalizing advice so that clients who never meet their Vanguard adviser face to face feel satisfied. "Generations X and Y, who grew up using the Internet," says Brennan, "will likely be more comfortable with a virtual relationship than their parents and grandparents."

Overall, however, managing director Michael Miller concedes, "We don't have it knocked yet," adding that 2004 is the year Vanguard expects to flesh out its plans for offering more extensive advice. It's safe to assume that Vanguard will continue hiring its own financial planners and will target investors rolling over retirement assets (who can already get an initial round of free advice if they bring in at least $100,000 in assets). The firm is also betting heavily on its OneStep program, which enables a company's workers to enroll automatically in a 401(k) plan, increases their contributions every year and steadily adjusts their asset allocation over time. As these investors age and move from accumulating assets to withdrawing them, OneStep will even advise them on how best to take money out of their accounts. "We want to add discipline and take emotion out of the investment program," says Brennan. "If we can take $800 billion and help people invest just 50 basis points [0.5%] better, that's $4 billion in incremental wealth we've created."

Growth with values

Having quintupled in size in eight years, Vanguard is showing some growing pains. Is it ready to face a future of even larger size and ever-growing demands from investors? First of all, Brennan vows not to change Vanguard's mutual structure: "We will never demutualize as long as I'm here. Put it in bold print. I will work here [only] as a mutual organization, because it's a better way to work, it's a better way to compete in the marketplace and it's who this organization is."

And what's Brennan's view of where Vanguard is heading? "We can't control the markets," he says, "but we can work like crazy to control what we do within those markets." Adds Brennan: "The company has to change regularly at a micro level, and not so much at a macro level. If the values of the organization are unchanged in 2014, in my opinion we'll be very successful." In other words, Brennan wants Vanguard to change what it does without changing the principles that placed it on the moral high ground of the mutual fund industry. And in the end, changing its services without changing its values may be Vanguard's biggest challenge of all.