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.