Wednesday marked the fortieth birthday of the most investor-friendly idea in stock market history: the index fund. Forty years ago Vanguard introduced the first fund that merely tracked the S&P 500. It has appreciated 6,334 percent since inception, trailing the S&P by a mere .14 percent annually, all of which was the ‘expense ratio’ charged investors. Few, if any other funds have matched or exceeded this annual return.
Today roughly $5 trillion is invested in index funds. Vanguard is the largest index manager, with over $3 trillion in assets under management (AUM). Other money managers now offer index products alongside their traditional, actively managed funds.
Study after academic study shows that index funds outperform most actively managed funds. The reason is simple. Fees. The average expense ratio for actively managed stock funds is around 1.5 percent. It is somewhat less for fixed income funds. As Vanguard founder John Bogle has convincingly shown, a fund with a 1.5 percent annual fee (and the same pre-fee annual return) will produce a much smaller total return over a multi-year period than a fund with a .14 percent annual fee.
Investors have taken notice. According to the Wall Street Journal, they have invested $409 billion in passive index funds in the last year and pulled $310 billion out of actively managed funds over the same period. Roughly 20 percent of all money in stock funds is now indexed, up from zero 40 years ago.
I suspect this trend will accelerate.
After one of the craziest rides anyone can remember, with the Dow dropping over 1000 points in a session for the first time and everybody learning the definition of “Rule 48,” stocks ended up pretty much where they began last week. Incredibly, the Dow, S&P and Nasdaq were actually up modestly by Friday’s close. Besides Xanax manufacturers, there were two clear winners in all of the sound and fury signifying not very much: the market’s croupiers—the brokers and Wall Street traders who collect commissions on stocks, bonds, and other financial products—and Mr. John Clifton Bogle.
As a Princeton graduate student in the 1970s, Bogle invented the index fund. Today almost 1/3rd of all mutual fund assets are invested in index funds and Bogle’s Vanguard Group is the nation’s largest money management firm as measured by assets under management. Study after academic study shows that the S&P 500 has produced an 8.5 percent annual return since World War II, while the average actively-managed mutual fund has delivered about 7 percent (after deducting the 1.5 percent average “expense ratio”). The typical retail investor lags far behind, earning closer to 5 percent a year. Weeks like this past one are a big reason why.
I’m always amazed—and a little horrified—at how poorly my industry treats its customers. Unlike many service professions, the licensing requirements for financial advisors are minimal, and far too many so-called “wealth managers” manage their own wealth first by promoting what John Bogle calls “salesmanship over stewardship.” Like real estate agents or used car salesmen, they push big ticket, financially destructive products with sizable embedded commissions.
But as incompetent and flat out dishonest as folks in my business can be, John and Jane Q. Public are often their own worst enemies. Through greed, gullibility, or gross negligence, people routinely blow large sums of their hard-earned savings. These five mistakes are, by far, the best ways to torch your net worth:
I am reading Vanguard founder John Bogle’s most recent book, The Clash of Cultures. It shares a common theme with many of his other writings: the investment management industry has increasingly promoted salesmanship over the stewardship of client assets. The evidence of this is everywhere–from the excessive fees for actively managed mutual funds to the excessive turnover of stocks in most funds to the proliferation of funds (including ETF’s) at many fund families.
I wish I could say that the hedge fund industry has done a better job than mutual funds and focused on stewardship over salesmanship, but I can’t. Hedge funds have been just as bad as mutual funds, especially when it comes to the oldest and most destructive temptation in the money management game: overgrowing one’s assets under management (AUM).
In 1984, when I was a fresh MBA working at the largest bank in Texas, I was browsing through the now-defunct magazine Investment Decisions and I came across an article titled, “Do Stock Splits Help Stock Prices?” It was written by a man I had never heard of. His name was Warren Buffett.
I generally find the public’s fascination with would-be financial messiahs puzzling, even pathetic. All my life, I’ve watched one market “guru” after another tout some secret formula for beating the street, only to fade into obscurity. But “The Wizard of Omaha” is an exception. He definitely deserves the fame he’s acquired. He’s delivered more helpful investment advice than any other living American. (Vanguard founder John Bogle is a close second in that regard.) Believe it or not, I have kept Buffett’s Investment Decisions article with me for the last 30 years. I’m looking at it right now as I type, and Buffett’s insights are as apt today as they were back in the days of Swatch watches and New Coke.