By Jonathan Burton, MarketWatch
The birth of the index fund
Vanguard cast its lot with indexing in August 1976 when Bogle launched the Vanguard First Index Investment Trust, later renamed the 500 Index Fund /zigman2/quotes/209016161/realtime VFINX -0.90% , which mirrored the performance of the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.90% . A fund that matched a market average was then an untested and uncertain breed — Vanguard’s offering was the first retail product of its kind.
Index funds don’t try to beat the market or buy and sell the latest hot stocks. They own a representative sampling of all the stocks in an index and go for the ride. Their main appeal is the ability to capture nearly all of a benchmark’s return efficiently and inexpensively — which, as Bogle always pointed out, is more than can be said for most actively managed funds.
Said Bogle: “Why can’t managers beat the market? Where’s the value added? In terms of industrywide statistics, it’s just not there. One reason is because of cost. The cost is a handicap on the horse. If the jockey carries a lot of extra pounds, it’s very tough for the horse to win the race.”
For Bogle, the value of an index fund is not that it can beat the market — it can’t. Indexing, he explained, is a proven way to realize considerably all of the market’s pretax gains. Additionally, index funds eliminate much of the guesswork and specific sector and company risk involved with investing. And that, Bogle contended, is worth every penny: “There’s no point in being contrarian about something that doesn’t make sense. An index fund always wins. It wins every single, solitary day, and there’s no way around it. The fact that everybody criticized it made me all the more sure.”
The fox and the hedgehog
Defending the virtues of indexing against the powerful forces of costly active management was Bogle’s lifelong fight — his crusade, really — and he was always one to rally to the ramparts. “The foxes are trying to manipulate people; they’re trying to manipulate investing,” he contended. “Foxes charge a premium for their services, because it’s supposedly so complicated and mere mortals can’t do it. But the hedgehog says, ‘Of course mere mortals can do it. Just understand the one great thing: Own the market, and own it at a very low cost. And you will demonstrably get 98% or 99% of the market return.’ ”
Yet even Bogle admitted that active fund management has its place in a portfolio. Indeed, Vanguard — truly “The House that Jack Built” — offers a broad array of active products. He explained: “I don’t want to push my argument too far, because I think there is room for professional managers who don’t feel bound by style boxes.” Meaning, trailblazers who are sensitive to shareholder costs and taxes. He added: “The chances of beating a fairly measured market starts with having your expenses as low as possible. The active managers who will succeed are those with low costs, relatively low turnover and relatively low cash positions.”
To be sure, with so many investors trying to make sense of so many mutual fund and exchange-traded fund choices, Bogle often seemed a lone voice in the wilderness as he implored investors to build their portfolios on a strong, simple, foundation. Said Bogle: “Simplicity is the master key to financial success. The more complex the world around us becomes, the more simplicity we must seek in order to realize our financial goals.”
Bogle’s own simple approach to investing rested on a few well-honed beliefs:
• Investing is not as difficult as it seems.
• Consider index funds first.
• Own stocks, but hold bonds as well. Build a broadly diversified stock portfolio with mutual funds. This will help mitigate the specific risk of owning just a handful of stocks. Better still, buy the entire stock market through a total stock-market fund.
• Don’t own too many funds, and don’t trade them. Fund managers within a particular category tend to own many of the same stocks, so it’s easy to pay twice for a similar portfolio.
• Think long-term. Markets fluctuate, and these short-term ups and downs usually are just noise. So don’t lose sight of bigger goals.
Said Bogle: “Buy right and hold tight.”
Bogle remained modest about his significant achievements. “I don’t think I’m anything like a folk hero,” he said. “But there aren’t a lot of people like me in this business. Most keep a lower profile, are much more guarded in the way they speak, and much less strident in their advocacy of shareholders’ values and rights. If this industry had one fox and 1,000 hedgehogs, maybe I wouldn’t stand out. But if it has 1,000 foxes and one hedgehog, you’re going to be more distinctive. You carry a different set of values and investment ideas. If it’s unusual — even unique — you will stand out.”
Jonathan Burton is a MarketWatch writer and editor based in San Francisco.